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Cape Town - Prolonging a low interest rate policy will not address the electricity shortages, and other infrastructure bottlenecks in the economy, says Overberg Asset Management is its weekly overview of the SA market landscape.
According to OAM the probability of a rate hike is rising in spite of sluggish economic growth, as the main culprits are supply-side driven.
The SA Reserve Bank’s (Sarb) Monetary Policy Committee (MPC) meets on Thursday to decide on monetary policy.
"The forward rate agreement market is pricing in a 50% probability that the benchmark repo rate will be raised by 25 basis points from 5.75% to 6.0%. This is up from the 13% probability priced in prior to the last MPC meeting in March," says OAM.
Although the chances of a repo rate hike on Thursday are evenly balanced according to the forward rate agreement (FRA) market, the FRA ascribes a probability of over 125% to a rate hike at the following MPC meeting in August, according to OAM.
Market overview
South Africa economic review
• Eskom confirmed solid progress on the commissioning of Medupi’s Unit 6. The unit ran for a record six days without a trip, the longest period of uninterrupted operation since its synchronisation on 2 March and the output level hit 735 megawatts (MW) - close to the full capacity of 749MW.
Meanwhile the Koeberg nuclear power station which has been down for planned maintenance since February is due to come back online by the end of May. Imminent full capacity at Medupi Unit 6 and Koeberg will add close to 1700MW of electricity to the grid, greatly alleviating the risk of power outages.
• In its quarterly review Moody’s credit rating agency as expected maintained its rating of SA’s foreign debt at Baa2 with a “stable” outlook. As usual the rating agency cited credit strengths and weaknesses and factors which might prompt a change in credit rating. Among factors which might prompt a credit rating downgrade, Moody’s cited slippage in the government’s commitment to fiscal consolidation and debt stabilisation. In this context the government last week capitulated to public sector wage demands with an increased offer of 7%.
• Manufacturing production increased by more than expected in March, rising 3.8% year-on-year, well above the 1.3% consensus forecast and more than reversing the -0.4% decline in February. On a month-on-month basis production increased 1.2% beating the 0.5% consensus. The improvement is attributed to fewer days of electricity supply disruption. However, despite the improvement in March manufacturing production still contracted in the first quarter by -0.6% quarter-on-quarter.
• Mining production increased in March by a robust 18.8% year-on-year, building on from the 7.8% increase in February, and by 7.1% month-on-month, substantially above the -0.4% expected decline. The rise in production is attributed to a surge in output of platinum group metals which increased 132.2% on the year and added 13.1 percentage points to the overall year-on-year gain. The production of coal and manganese also fared well, with respective year-on-year increases of 9.0% and 17.3%. On a quarter-on-quarter basis mining production increased by 1.9%.
• In its quarterly review the National Association of Automobile Manufacturers (Naamsa) lowered its forecast for new domestic car sales in 2015 from a previous 671 000 to 659 000. The downgrade is influenced by disappointing car sales so far this year, down in the first quarter (Q1) by -0.8% year-on-year. However, exports are performing well, with Naamsa forecasting that vehicle exports will rise from 276 873 in 2014 to 320 500 in 2015, helped by the low base effect from last year’s strike activity and eurozone demand recovery.
• Foreign investors sold R2.3bn worth of SA bonds in the past week and bought R4.0bn worth of equities. Over the month of May-to-date foreign investors sold R1.6bn worth of bonds and bought R2.8bn worth of equities, while for the year-to-date foreign investors bought R7.6bn and R20.7bn worth of SA bonds and equities respectively. Foreign investors accounted for a lower than usual portion of daily trade volume, measuring 35.8% of total market activity in the past week, below the 42.8% year-to-date average. The below average reading is attributed to a global upward move in bond yields which is spilling over into reduced appetite for SA bonds.
SA political review
• The Eskom “war room” headed by Deputy President Cyril Ramaphosa instructed the Treasury to look at ways to sell up to 30% of Eskom as a means of raising funds for the energy provider and to bring in private sector expertise. However, privatisation is a contentious issue for the ANC with the news attracting swift criticism from Cosatu. The Public Enterprises Minister Lynne Brown also rejected the privatisation of utilities that are supposed to provide basic services. A compromise which has been reportedly tabled by the ANC is for an Eskom stake to be sold to the Public Investment Corporation, although this solution would exclude the introduction of private sector expertise.
• The Association of Mineworkers and Construction Union (Amcu) submitted its gold and coal sector wage demands, demanding a doubling in the lowest basic wage from R6 000 to R12 500 and a doubling in housing benefits to R4 000. The demands signal a difficult round of wage negotiations. Amcu’s presence has grown, now representing around 29% of workers in the gold sector. The existing wage deals in both gold and coal sectors are due to expire at the end of June.
The week ahead
• The release of the first quarter labour force survey, which was due for release on Tuesday, has been postponed to 28 May 2015. According to consensus forecast the unemployment rate is expected to rise slightly to 25.0% in the first quarter (Q1) from 24.3% in Q4 2014. The rise is attributed to the ending of festive season part-time employment contracts and the seasonal increase in first time job seekers.
• Consumer price inflation (CPI) is due on Wednesday, 20 May. According to consensus forecast CPI is expected to accelerate from 4.0% year-on-year in March to 4.8% in April.
• Retail sales, also due on Wednesday, 20 May. According to consensus forecast retail sales are expected to slow from year-on-year growth of 4.2% in February to 3.1% in March.
• The SA Reserve Bank’s (SARB) interest rate decision is due on Thursday, 21 May. Although the probability of a repo rate hike from 5.75% to 6.0% is finely balanced according to the forward rate agreement market, the consensus view among economists is that there will be no rate hike at the upcoming policy meeting. The economy remains weak and consumer price inflation is well within the SA Reserve Bank’s % target range of 3% - 6%. Moreover, Sarb governor Lesetja Kganyago in an interview reported that the Monetary Policy Committee (MPC) would not necessarily respond to a temporary breach of the inflation target.
Technical analysis
• The rand remains below successive support levels suggesting a continuation in the rand’s depreciation. A break below the R10.80/$-level is needed to signal a disruption of the depreciation trend line which has been in place since 2011. A break above the key “Fibonacci” level of R12.15/$ would open up a further depreciation in the rand to the R13.00-level.
• 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.
• 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 below key resistance levels of 2.40% and 2.0% indicating a trading range of 1.70% - 2.2% over the medium-term. 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 is testing support at 8.15% and needs to break below resistance at 7.90% in order to resume its bull trend.
• The MSCI World Equity index is in the 5th and final wave of a rising-wedge formation. A rising-wedge formation is a typical trend-ending signal. European equities are set to outperform US markets. The Nikkei exhibits the most bullish pattern.
• 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 can be expected in the next year. 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.
• In the meantime the S&P 500 is displaying a bullish short-term pattern. The index is moving into an advanced triangle pattern which normally signals the continuation of an upward trend. If the S&P 500 breaks above resistance at 2 070 a further upward move to 2 150 is likely. This view is corroborated by the “downward flag” of the Dow Jones index, which is also associated with an upward break-out.
• Although enjoying a temporary respite Brent crude had previously broken below key support levels at $60 and $50 suggesting a continuation of the weakening long-term trend. Copper is regarded a reliable lead indicator for industrial commodity prices and barometer of global economic growth. It has broken below the 2011 low of $6 500 suggesting a further downside move to $5 500.
• Despite recent advances, gold is in a protracted bear market signalled by rapid declines through successive support levels at $1 400, $1 300 and $1 250. Gold’s next target is $1 100 and is likely to breach $1 000 before the bear market ends.
• The All Share index has broken to new highs exceeding the 55 000 level for the first time indicating a continuation of the long-term upward trend.
Bottom line
• Inflation expectations are rising. The Sarb’s latest consumer price inflation (CPI) forecast for 2015 has increased from a previous 3.8% to 4.8%. The central bank also forecasts that due to low base effects in early 2015 CPI will breach the upper-end of its 3% - 6% target range in the first quarter of 2016.
• What is causing CPI to go higher? The oil price has rebounded almost 20% in dollar terms since the start of the year and expected to lift domestic fuel prices further in coming months. The maize price has increased around 30% since the start of the year due to the severe drought in maize growing regions. Eskom has applied for a 25.3% tariff increase, indicating a substantial rise in administered prices. The public sector wage increase is still in negotiation and may create a precedent for high wage settlements across the economy. Inflationary expectations will rise if the public sector wage agreement is in excess of the inflation rate.
• Meanwhile expectations are rising that the US Federal Reserve will soon embark on its cycle of monetary policy normalisation. The first Fed rate hike is likely at the September meeting, although may come as soon as June. Rate hikes in the US will pressure the rand and lead to an increase in imported inflation.
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Disclaimer: Information and opinions presented in this report were obtained or derived from public sources that Overberg Asset Management believes are reliable but makes no representations as to their accuracy or completeness. Any opinions, forecasts or estimates herein constitute a judgement as at the date of this Report and should not be relied upon. There can be no assurance that future results or events will be consistent with any such opinions, forecasts or estimates. Furthermore, Overberg Asset Management accepts no responsibility or liability for any loss arising from the use of or reliance placed upon the material presented in this report.
