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No escape for SA from possible US rate shocks

Cape Town - A US rate hike will have repercussions for all global financial markets including SA’s forex, bond, credit and equity markets, Overberg Asset Management (OAM) warned in its weekly overview of the SA economic landscape.

The Fed’s interest rate decision on Thursday will be one of the year’s most closely watched global financial events as a hike will be the first in almost a decade, putting an end to the US central bank's seven years of zero interest rate policy.

Economists and analysts are split over whether the Fed should hike or not. On the one hand unemployment is back to levels which would normally warrant interest rate increases as any further jobs growth could lead to a spike in wages and inflation pressure.

However, inflation and inflation expectations have remained much lower than the Fed’s target. Some analysts believe the Fed is already way behind the curve and that any further delay in hiking rates could risk future global stability.

The opposite argument is that the global financial outlook is already at risk due to the slowdown in China and emerging markets, necessitating a postponement in the Fed’s rate hike.

South Africa economic review

• Mining production increased in July by 5.6% year-on-year up from 4.0% in June and well above the 1.6% consensus forecast. On a month-on-month basis mining production increased 1.1% while June’s figure was revised upwards from an initial 1.1% to 2.0%.

Iron ore production increased 18.7% on the month reversing the contractions of -8.7% and -8.2% in May and June. Coal production increased 3.1% on the month while gold and platinum group metals production shrunk by -4.4% and -2.9%.

Overall, the production data is encouraging despite continued load shedding and weak mining resource prices.

• Manufacturing production increased in July by a stronger than expected 0.3% month-on-month and 5.6% year-on-year above the respective consensus forecasts of -0.75% and 1.4%. The improvement was broad-based with seven of the ten manufacturing sub-sectors showing positive growth.

Following the surprise GDP contraction in the second quarter (Q2), which was led by sharp declines in manufacturing and mining output, July’s positive data suggests a recovery in GDP growth in Q3. Eskom’s guidance that it expects to avoid further load shedding until April next year should support better GDP prospects in Q3.

• The third quarter RMB/BER business confidence index fell for a third straight quarter from 43 in the second quarter (Q2) to 38 in Q2 well below the 42 consensus forecast and substantially below the key 50 level which demarcates expansion from contraction.

Business confidence was low across all five surveyed sectors but notably weak in consumer related sectors with retail business confidence falling from 52 to 34 the weakest since 2009. In recent years consumer spending has propped-up GDP growth making the fall in retail business confidence especially concerning. Among the other sectors manufacturing confidence increased slightly from 29 to 34 but still in deep sub-50 contractionary territory.

Building confidence fell from 48 to 45, one of the highest sector readings. The feeble business confidence data may deter the SA Reserve Bank from hiking interest rates again at its September policy meeting in two weeks’ time.

• The 2015 Open Budget Survey which measures countries according to their budget transparency ranked SA third out of 109 countries just behind New Zealand and Sweden confirming that despite investor concerns some of SA’s institutions remain world-class. SA’s score dropped to 86 out of 100 having been as high as 90 in 2012 when it ranked second behind New Zealand. The survey measures the degree to which governments make key documents available to the public in a timely manner and the degree of usefulness of the data.

• In the past week foreign investors sold a net R2.2bn worth of domestic bonds and sold a net R4.0bn worth of equities, reversing the R5.3bn worth of equities purchased the previous week. Foreign buying was evident in the industrial sector and property sector while selling was evident in the financial sector and resource sector.

Foreigners’ contribution to total market traded volume was lower than average at 33.3% compared with the average for the year-to-date of 38.3%. For the year-to-date foreign net buying of bonds and equities amounts to R10.39bn and R36.49bn respectively.

South Africa political overview

• A policy discussion document attributed to Obed Bapela (head of the National Executive Committee on International Relations) suggested the ANC was considering scrapping dual citizenship. Bapela said the proposal was partly aimed at preventing SA citizens from serving in the Israeli military drawing strong condemnation from the SA Jewish Board of Deputies and the SA Zionist Federation. The government distanced itself from the scrapping of dual citizenship, which it recognizes would be a material breach of the Constitution.

Home Affairs Minister Malusi Gigaba stated that a government review of Bapela’s proposals is not in process and that scrapping dual citizenship would be a “mistake of historic proportions”. ANC spokesperson Zizi Kodwa stated that: “We want to reassure South Africans that in terms of our national policies, we are aligned with the generally accepted practice by the majority of countries in the world who recognize dual citizenship.”

The week ahead

• SA Reserve Bank (SARB) Quarterly Bulletin for the second quarter was released on Tuesday. The SARB quarterly Bulletin showed that the current account deficit narrowed to a 4-year low of 3.1% of gross domestic product from a revised 4.7% in the previous three months. The Bulletin also showed growth in household spending slowed to 1.2% from 2.4% in the first quarter, while investment spending rose 1% from 1.8%.

• Retail sales for July is due on Wednesday, September 16. Following June’s strong growth of 3.5% year-on-year, retail sales growth is expected to slow to 2.4% in July according to consensus forecast as the benefit of low year-ago comparative figures dissipates. 

Technical analysis

• 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 no sign yet 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 is testing support at 8.70% which if broken could open a new target of 9.5%.

• The MSCI World Equity index has broken downward from a rising wedge formation which has been intact since the 2008/09 global financial crisis. It is unlikely that the downward move is over as the correction so far is too small for a bull market of the magnitude and duration of the 2009-2015 bull market. The downside target for the MSCI World Equity index is 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 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.

• The S&P 500 has broken down from a rising wedge pattern, which is traditionally a trend-changing pattern. The break below the 2 070 level confirms a reversal of the upward trend. 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 $50 support level suggests 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 key $5 300 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 $1 300, $1 250 and $1 100. Gold’s next target is $1 000 which is likely to be breached before the bear market ends.  

• The All Share index has broken below its bull market support level which has been intact since 2009. The downside target for the All Share index is 41 000.

Bottom line

• Concerns over China’s slowdown appear to be gaining the upper hand: The fed funds futures market ascribes a 30% probability to a Fed rate hike on Thursday down sharply from the 66% probability a month ago. Economists are also veering towards predicting no rate hike.

• Ironically the Fed’s interest rate decision is unlikely to cause as much volatility in global financial markets as might be expected given the level of debate. The vast majority of US mortgages are linked to long-term interest rates rather than short-term rates and as such a rate hike would not cause a significant drag on the real economy.

• While a Fed decision to keep rates on hold may prompt a relief rally in “risk” assets such as equities and emerging market currencies, the rally is only likely to be temporary. The expectation will remain that the Fed will hike rates later in the year either in October or December.

Meanwhile the Fed rate decision will do little to alleviate the bleak global economic outlook characterised by China’s slowdown, deteriorating global earnings growth, weak regional purchasing managers’ indices and loss in momentum in global lead economic indicators.

For the full report, including a look at international markets, click here.

* 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.

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.

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