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Looming Fed rate hike will undermine rand - OAM

Cape Town - Rate hikes by the Federal Reserve will undermine the rand as the yield advantage of rand denominated bonds starts to diminish, according to Overberg Asset Management (OAM).

It noted that Fed chair Janet Yellen told a Congressional committee last week that a rate hike is imminent, signaling a 25 basis point increase in December.

Trumponomics contains more ominous features. Trade protectionism and restrictions on immigration will affect import costs and wage costs, leading to a significant increase in inflation. The Fed will respond to higher inflation with faster than expected monetary tightening.

The pace of rate increases should speed up in 2017 and 2018 as Trump’s economic policies take shape.

South Africa economic review

• Retail sales grew in September by 1.4% year-on-year up slightly from 1.0% in August. In the third quarter (Q3) sales increased by 0.9% on the year.

However, on a quarter-on-quarter basis sales declined by -0.2%, confirming the weak retail environment. Certain retail sectors performed well, including “food, beverages and tobacco” which increased 10.9% on the year, “pharmaceuticals and medical goods, cosmetics and toiletries” and “hardware, paint and glass”, which grew 6.5% and 4.9% on the year.

The retail outlook is hamstrung by weak consumer confidence, high consumer indebtedness and tight credit conditions. The poor household spending data is consistent with third quarter (Q3) GDP growth of around 0.3% quarter-on-quarter annualised down significantly from 3.3% in Q2.  

• The National Minimum Wage Panel released its proposed national minimum wage (NMW). The proposed NMW was R3 500 falling halfway between the R2 000 to R2 500 maximum proposed by businesses and the R 4500 minimum proposed by other social partners. The panel also proposed that domestic worker wages should be set at 75% of the NMW and agricultural wages at 90%.

Panel chairperson Professor Imraan Valodia said 47% of those who work earned less than the proposed minimum wage. There is no precedent for a national minimum wage in South Africa or for any country with equally elevated unemployment.

Hence the effects are difficult to predict. The panels’ report cautioned that: “It must be noted that there is no research or data that can accurately predict the outcome of any policy.”

• Auditor General Kimi Makwetu announced that irregular expenditure by state entities had risen by 80% in the past financial year to R46bn.

The Passenger Rail Agency of South Africa (PRASA) was the biggest culprit with R13.9bn in irregular expenditure, followed by the health departments of KwaZulu-Natal and Mpumalanga, the department of water and sanitation and Guateng’s road and transport and human settlements departments.

The bulk of the irregular expenditure is due to incorrect procurement procedures. Makwetu expressed concern over the financial future of state-owned enterprises: “The poor leadership included instability at board level, vacancies in key positions, inadequate consequence management and poor monitoring and oversight of procurement processes …”

• Reporting on the improved outlook for maize harvests this year Grain SA chief executive Jannie de Villiers reported that: “With the conditions as it is at the moment, we can expect a surplus crop.”

The maize crop fell from 9.95 million tons in 2015 to 7.5 million in 2016 but should exceed 10.5 million tons in 2017, the level required to meet local demand. The US Department of Agriculture reported earlier this year that South Africa’s maize harvest could exceed 13 million tons due to favourable La Nina weather patterns.

The week ahead

• Quarterly Labour Force Survey: Due Tuesday 22nd November. Unemployment in South Africa rose to 27.1% in the third quarter of 2016, Statistics South Africa announced on Tuesday.

• Consumer price inflation (CPI): Due Wednesday 23rd November. According to consensus forecast CPI is expected to pick-up from 6.1% year-on-year in September to 6.3% in November.

This is above the South African Reserve Bank’s 3-6% target range.

• Producer price inflation (PPI): Due Thursday 24th November. According to consensus forecast PPI is expected to slow from 6.6% year-on-year in September to 6.0% in October in response to lower food price inflation.

A deceleration in PPI would bode well for a decline in CPI around mid-2017.

• South African Reserve bank (SARB) Monetary Policy Committee (MPC) meeting: Due Thursday 24th November. Despite CPI breaching the upper limit of its target range the SARB is expected to keep its benchmark repo interest rate unchanged at 7%.

At its last policy meeting the SARB lowered its inflation forecasts and hinted that it was close to the peak in the current tightening cycle.

• Moody’s credit rating update: Due Friday 25th November. Moody’s will release its update of South Africa’s foreign currency credit rating.

The Moody’s credit rating is currently one notch above investment grade at Baa2 but with a “negative outlook”. This suggests the next move will be a downgrade to investment grade.

Technical analysis

• While the rand has broken below key resistance levels versus the dollar at R/$ 14.20 and 13.80 the strengthening trend is not confirmed by momentum indicators, signalling that the currency is overbought.

• 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.

• Following the Brexit vote the British pound hit its weakest level against the US dollar since 1985. The £/$1.30 level provides key support, which if broken would open up a Fibonacci projected target of £/$1.20-1.24.

• 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 back above the key support level of 2.0% endangering the multi-year bull trend in US bonds.

• The benchmark R186 SA Gilt yield is now testing the key support level of 9.0% endangering the mini-bull market in bonds which has been in place since the start of the year.

• The MSCI World Equity index has broken downward from a rising trend-line 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 between mid-2016 and mid-2017.

• The S&P 500 index has broken to new record highs but the rally is not being confirmed by momentum indicators, which suggests the market is overbought and in danger of correction. A further negative signal is that the Dow Jones Transport Index, traditionally a lead indicator for the broader market, is underperforming the broader index.

• Despite this year’s price rally Brent crude’s break below the key $30 support level in February suggests a continuation of the weakening long-term trend to a downside $25 target.

Copper is regarded a reliable lead indicator for industrial commodity prices and barometer of global economic growth. Despite its recent rally the copper price broke below the key $4 500 support level in February suggesting further downside ahead.  

• Gold has developed an inverse “head and shoulders” pattern, which indicates further upward momentum and a test of the $1400 target level.

• The JSE All Share index is testing an important resistance line but if this remains unbroken the index is likely to move back below the 24-month moving average at 50 900 in turn opening a downside target of 45 000. A break above 54 200 on the JSE All Share index would project an upward move to 60 000 marking a new high for the JSE

The bottom line

•  The US election result took most people by surprise. The subsequent reaction of financial markets was equally surprising. Unexpectedly, US equity markets surged to new record highs and the dollar scored its best three-day rally since 2011. As well as winning the presidency Trump will be supported by a Republican Congress.

The Republican party made a clean sweep of Congress winning a majority in both the Senate and House of Representatives. With Congressional support his polices should be endorsed. However, Trump’s will be unable to gain Congressional support for his more controversial policies, such as building a wall along the Mexican border.

In his acceptance speech Trump dismissed this and other key threats such as the repeal of Obamacare.

• The main pillars of Trump’s economic policy (Trumponomics) comprise infrastructure spending, tax cuts and de-regulation, a powerful cocktail of business-friendly measures.

Trump has pledged to invest $100bn per year on additional infrastructure spending, boosting GDP by around 0.5% per annum. Trump also plans to cut company taxes, which should boost business investment spending. Business investment spending combined with deregulation will promote much needed productivity gains.  

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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