Cape Town - The Forward Rate Agreement market is fully pricing-in a 50 basis point interest rate hike when the SA Reserve Bank concludes its monetary policy meeting on Thursday.
"The main culprit is inflation," says Overberg Asset Management (OAM) in its weekly overview of the SA economic landscape.
"The inflation outlook has deteriorated since the last monetary policy meeting in November due to the intensification of the drought and the sharp depreciation of the rand.
"With household expenditure hamstrung by low consumer confidence, declining disposable income and slow employment growth, one might ask what the point is of hiking interest rates. SA’s inflation threat is clearly supply-shock related rather than due to any demand-pull pressure.
"The argument is that higher interest rates will encourage capital inflows and help strengthen the rand. However there is scant evidence of any pass-through inflation from the depreciating rand," according to OAM.
OAM says a weakening global environment will stifle the inflationary impact of a depreciating rand.
"While the consensus forecast is for a 50 basis point interest rate increase on Thursday we believe the Reserve Bank will stick to its gradualist approach and limit the rate hike to 25 basis points."
South Africa economic review
• Consumer price inflation (CPI) accelerated from 4.8% year-on-year in November to 5.2% in December in line with consensus forecast. The main culprit was food price inflation which increased from 4.8% to 5.9%. Food prices comprise around 15% of the CPI basket. Core CPI excluding the volatile food and energy sectors also increased although only slightly from 5.1% to 5.2% in line with consensus forecast.
Both headline and core CPI measures remain comfortably within the SA Reserve Bank’s (Sarb) 3-6% target range and so far there is little evidence of any inflationary spillover from the weaker rand. Goods which are usually most prone to currency-induced inflationary pressure such as clothing and vehicles have barely shown any price increases.
The inflation data may be moderate enough to dissuade the Sarb at its policy meeting on Thursday from hiking the repo rate by the consensus forecast 50 basis points.
• Retail sales showed surprising resilience in November increasing 2.5% month-on-month the strongest monthly increase since June 2012. On a year-on-year basis retail sales increased 3.9% up from 3.4% in October and beating the 2.9% consensus forecast.
The gain is attributed to the “general dealers” category which increased 5.0% on the year and the “textiles, clothing, footwear and leather goods” category which increased 5.8%, adding 1.9 and 1.2 percentage points respectively to the headline figure. The “household furniture, appliances and equipment” category suffered the worst performance declining -10.7% on the year, contracting on an annual basis for the fourth consecutive month.
While encouraging the current pace of retail sales growth is unlikely to be sustained over 2016. The FNB/BER consumer confidence survey fell to a multi-year low in the fourth quarter 2015 reflecting constrained household finances. Disposable income is being affected by slow jobs growth, higher inflation, and rising debt servicing costs.
• The IMF cut its forecast for SA’s GDP growth for 2016 from a previous 1.3% to 0.7% and for 2017 from 2.1% to 1.8%. While disappointing it is some consolation that SA was not the only country to have GDP forecasts revised lower. Many other emerging economies are expected to lose growth momentum due to lower commodity prices and rising borrowing costs.
The World Bank’s forecast for 2016 has also been revised sharply lower from 2.1% to 1.4%. In its World Employment Outlook the International Labour Organisation forecasts that due to weak economic growth the number of unemployed in SA would increase by 300 000 people by the end of 2017.
• In its report on rating trends in sub-Saharan Africa credit rating agency Standard & Poor’s (S&P) warned that SA faced another tough year and that slow economic growth was a major impediment to the country’s creditworthiness.
A slow growth rate combined with the growing financial needs of state-owned enterprises could undermine the country’s fiscal consolidation objectives. S&P cited weak European demand for SA’s exports, low commodity prices, electricity shortages, and weak domestic business and consumer confidence, as significant growth constraints. The rating agency also identified the high level of foreign ownership of SA’s bonds as a key risk.
• After being net buyers of SA government bonds in the first two weeks of the year, foreigner investors sold a net –R5bn worth of SA bonds in the third week of January lifting the year-to-date capital outflow from the bond market to –R3.7bn.
Foreign investors were net sellers of a further –R6bn worth of SA equities in the past week bringing year-to-date net sales to –R13bn. Combined bond and equity market capital outflows have already reached –R16.7bn in the first three weeks of the year largely explaining the sharp -6.5% depreciation in the rand/dollar exchange rate.
SA political review
• The Presidency’s delegation to the World Economic Forum meetings in Davos were attended by no less than seven cabinet ministers, in addition to the SA Reserve Bank Governor Lesetja Kganyago and the ANC Treasury General Zweli Mkhize. There are allegations of wastefulness being levelled at the cost involved especially as President Zuma withdrew from the much vaunted panel discussion on Africa.
However, the counter-argument is that the ANC is attempting to limit the President’s exposure to the financial world due to the potential liability this would present. In a separate Davos discussion panel Minister of Finance Pravin Gordhan stated that within the ANC “there are a significant number of us who want to restore integrity.”
The week ahead
• SA Reserve Bank Monetary Policy Committee meeting: Due Thursday 28th January. The Reserve Bank is expected to lift the benchmark repo interest rate by 50 basis points to 6.75% departing from its gradualist policy of incremental 25 basis point interest rate hikes. This would lift the Prime lending rate to 10.25%. (See “Bottom Line” for more commentary).
• Producer price inflation (PPI): Due Thursday 28th January. According to consensus forecast PPI is expected to accelerate from 4.3% year-on-year in November to 4.9% in December. The increase in prices is expected to be broad-based but especially pronounced in the food category due to the intensifying drought.
• Private Sector Credit Extension: Due Friday 29th January. According to consensus forecast credit extension growth is expected to increase from 9.5% year-on-year in November to 9.8% in December. However, demand growth is expected to remain subdued for the remainder of the year. Household credit demand is waning due to rising inflation and interest rates, and weak employment growth. At the same time lending standards are tightening.
• Trade balance: Due Friday 29th January. According to consensus forecast the trade balance is expected to improve from the R1.8bn surplus in November to a surplus of R4.7bn in December helped by the sharply weaker rand and seasonal factors. There are traditionally fewer imports during the December holiday season.
• The rand remains below successive support levels suggesting a continuation in the rand’s depreciation. Although the rate of the rand’s depreciation is accelerating there is little sign so far of panic selling or capitulation. This stage needs to be reached before a reversal in the rand’s move can occur.
• The US dollar index is testing a major 30-year resistance line, which if broken will pave the way for further strong gains in the currency.
• Despite the recent uptick in bond yields the long-term JPMorgan global bond index bull trend remains intact, with the yield targeting a new low during the fifth and final wave.
• The US 10-year Treasury yield has broken above key resistance levels of 2.0% and 2.2%. However, there is unlikely to be a major bear trend in US bonds as the deleveraging phase is still in its early stages.
• The benchmark R186 SA Gilt yield broke out of its long-term bull trend as a result of “Nenegate”. The new bear trend for the R186 is underpinned by resistance at 9.0% with a risk of further upside to 10.50%. While SA bond yields may fall in line with global bonds they are unlikely to return to the bull trend.
• The MSCI World Equity index has broken downward from a rising wedge formation which has been intact since the 2008/09 global financial crisis. Given the magnitude and duration of the 2009-2015 bull market the overall correction is likely to reach a downside target for the MSCI World Equity index of 1 400.
• Since the 1950s the Dow Jones and S&P 500 have displayed 7-year up-cycles and the top of the current US equity cycle is likely to have just occurred. The next major wave down will complete the 16-17 year secular bear market that started in 2000. The secular bottom should occur around June 2016.
• The S&P 500 index has broken downward from a rising wedge pattern, which is traditionally a trend-changing pattern. The downward trend is likely to remain intact unless the index decisively regains the 2070 level. A further negative signal is that the Dow Jones Transport Index, traditionally a lead indicator for the broader market, is leading the broader market lower on the downside.
• Brent crude’s break below the key $30 support level suggests a continuation of the weakening long-term trend to a downside target of $25. Copper is regarded a reliable lead indicator for industrial commodity prices and barometer of global economic growth. It has broken below the key $4 500 support level suggesting further downside ahead.
• Despite recent advances Gold is in a protracted bear market signalled by rapid declines through successive support levels at $1300, $1250 and $1100. Gold’s next target is $1000 which is likely to be breached before the bear market ends.
• The JSE All Share index remains below the 24-month moving average at 50 600. The recent consolidation pattern between 47 000 and 49 000 is likely to be resolved with a break to the downside to an initial target of 45 000 and an ultimate target of 43 000.
• The Forward Rate Agreement market is fully pricing-in a 50 basis point interest rate hike when the SA Reserve Bank concludes its monetary policy meeting on Thursday. While some economists are forecasting a 25 basis point rate hike the majority are leaning towards 50 basis points.
• The main culprit is inflation. The inflation outlook has deteriorated since the last monetary policy meeting in November due to the intensification of the drought and the sharp depreciation of the rand. Since November maize prices have surged 71% and the rand has weakened by 16% versus the dollar.
Food price inflation has already spiked higher from 4.8% year-on-year in November to 5.9% in December. Administered price inflation is also to blame, surging from 4% in November to 5.8% in December due to higher utilities prices. Further increases are expected with Eskom applying to Nersa for a 16.6% tariff increase this year.
• Consumer price inflation is still contained at 5.2% but expected to temporarily breach the upper end of the Reserve Bank’s 3-6% target range in February and thereafter for a prolonged period between the third quarter 2016 and final quarter 2017, peaking at 7.3% by year-end.
• By contrast the economy has almost stalled. The Markit composite purchasing managers’ index (PMI), measuring conditions across the whole economy, was 49.1 in December for a seventh consecutive month. This is below the key “50” threshold which demarcates expansion from contraction. The economy narrowly escaped recession after growing at an annualized rate of 0.7% in the third quarter but there is little chance of any pick-up.
With household expenditure hamstrung by low consumer confidence, declining disposable income and slow employment growth, one might ask what the point is of hiking interest rates. SA’s inflation threat is clearly supply-shock related rather than due to any demand-pull pressure.
• The argument is that higher interest rates will encourage capital inflows and help strengthen the rand. However there is scant evidence of any pass-through inflation from the depreciating rand. This is due to generally lackluster domestic demand, and the disinflationary impact of the lower rand oil price.
The global backdrop has also assisted with global inflation heading lower due to weak commodity prices and declining economic momentum. Global GDP data has headed steadily lower over the past three month prompting the IMF to lower its forecast for global GDP growth for 2016 from a previous 3.6% to 3.4%.
• A weakening global environment will stifle the inflationary impact of a depreciating rand. While the consensus forecast is for a 50 basis point interest rate increase on Thursday we believe the Reserve Bank will stick to its gradualist approach and limit the rate hike to 25 basis points.
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* Overberg Asset Management (OAM) is an Authorised Financial Services Provider No. 783. Overberg specialises in the private management of local and global discretionary portfolios as well as pension products.
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