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Moody's downgrade unlikely as bond market signals upswing

Jan 31 2018 11:31

Cape Town - Its unlikely that Moody's will downgrade South Africa’s local currency sovereign bonds to junk status, as the country’s risk premium reduces in tandem with a stronger rand.

This according to Overberg Asset Management in its weekly economic and market overview.

OAM said the consensus view of the "country's risk premium being back at levels last seen prior to Zuma’s firing of Finance Minister Nene", is a positive indicator of where the economy is heading.

South Africa economic review

• Headline producer price inflation (PPI) picked-up slightly in December to 5.2% year-on-year from 5.1% in November. On a month-on-month basis PPI increased from 0.5% to 0.6%. However, the recent downtrend is expected to reassert itself in coming months. PPI for intermediate manufactured goods slowed from 4.2% to 3.2% on the year and decreased by 0.4% on the month.

PPI for utilities slowed from 4.0% to 3.3% on the year and fell 1.8% on the month due to a decline in the price of water and electricity. PPI for agriculture, forestry and fishing slowed from 6.9% to 6.4% on the year.

The likelihood of a strengthening rand and subdued food prices should help headline PPI decelerate from an average of 4.9% in 2017 to the 4% level in 2018 paving the way for further declines in consumer price inflation.

• Headline consumer price inflation (CPI) nudged higher in December to 4.7% year-on-year from 4.6% in November. The biggest culprit was the transport category lifted by a 14.2% fuel price increase. Core CPI, excluding food and energy prices, decelerated from 4.4% to 4.2% and increased month-on-month by only 0.3%. Inflation for durable and semi-durable goods eased to 0.3% and 0.9% on the year from 0.5% and 1.6%, respectively.

Services inflation slowed from 5.5% to 5.3%. Prospects for a strengthening rand, subdued food prices, and downward trending producer price inflation should help headline CPI fall to below 4.5% in the first half of the year. The benign inflation outlook will hand the South African Reserve Bank an opportunity to cut interest rates.

•  Net foreign investor inflows into the South African equity market jumped last week to R8.966bn lifting the total net inflow for the year-to-date to R14.39bn.

The positive endorsement by foreign investors coincides with a successful showing by Team SA at the World Economic Forum conference in Davos. The surge in interest from foreign investors provides a strongly bullish signal for the JSE. A bull market in South African equities is typically characterised by strong foreign participation.

The bond market meanwhile was less fortunate. Foreign investors sold a net R5.0bn in South African bonds last week maintaining year-to-date net outflows at R5.03bn.

• The South African Reserve Bank composite leading business cycle indicator registered 105.4 in November unchanged from October’s level although still at its highest since 2012. The leading indicator is a barometer for economic conditions six months ahead. Of the ten sub-components making up the leading indicator, six improved and four deteriorated.

The biggest contributors were the increased hours worked in the manufacturing sector followed by an acceleration in the number of new passenger vehicles sold. The biggest detractors were the decreased number of residential building plans passed and deceleration in job advertising space.

At current levels, the leading business cycle indicator is consistent with annualised GDP growth of 3%, well above consensus forecasts. Improved confidence post the ANC elective conference should boost the leading indicator further in December and into the first quarter 2018, potentially signalling GDP growth in excess of 3% in the second half of the year.

The week ahead

• Private sector credit extension: Due Tuesday 30th January. Growth in private sector credit extension (PSCE) is expected to slow slightly in December to 6.0% year-on-year from 6.5% in November. In the year to end November PSCE grew on average by 5.7% down from almost 7% in 2016. An acceleration is anticipated in 2018 helped by lower inflation, stable interest rates and increased business and consumer confidence.

• Trade balance: Due on Wednesday 31st January. The trade surplus is expected to jump in December due to the traditional slowdown in imports at that time of year. A surplus of around R12bn is anticipated, which would lift the total surplus for the year to R77bn a substantial increase on the R1bn surplus recorded in 2016.

Buoyant global trade and rising commodity prices should keep the trade balance in surplus during 2018 although the surplus may reduce slightly compared with last year on increased import volumes.

• Absa manufacturing purchasing managers’ index: Due on Thursday 1st February. Having languished below the key 50-level, which demarcates expansion from contraction, for the greater part of last year the manufacturing purchasing managers’ index (PMI) is likely to move back into expansionary territory during 2018.

The PMI should benefit from the change in government economic policy following the outcome of the ANC elective conference.

• New vehicle sales: Due on Thursday 1st February. January is traditionally a strong month for vehicle sales as buyers typically postpone purchases to obtain new year registrations.

The National Association of Automobile Manufacturers of South Africa (NAAMSA) forecasts new vehicle sales will increase in 2018 by 2.6% year-on-year building on the 1.7% growth recorded in 2017.

Technical analysis

• Having broken key resistance levels at R/$13.50 and R/$12.50, the rand has returned to its appreciating trend, targeting a break below R/$11.70 over coming months.

• The US dollar index has tried but failed to break through a major 30-year resistance line suggesting the three-year bull run in the dollar may be over.

• The British pound has broken above key resistance at £/$1.35 promoting further near-term currency gains to a target range of £/$1.40-1.50.

• The JPMorgan global bond index is testing the support line from the bull market stemming back to 1989, which if broken will project further sharp increases in bond yields.

• The US 10-year Treasury yield has failed to break below key resistance at 2.0% raising the probability that the multi-year bull trend in US bonds is over.

• The benchmark R186 2025 SA Gilt yield has broken below key resistance at 9.0% indicating the potential for a new target trading range of 8.0-8.5%.

• Key US equity indices, including the S&P 500, Dow Jones Industrial, Dow Jones Transport, Nasdaq and Russell 2000, have simultaneously set new record highs, confirming a bullish outlook for US equity markets.

• The Brent oil price has broken above key resistance at $60 and likely to remain in a trading range of $60-70 over the foreseeable future. Base metal prices are in a bull trend confirmed by copper’s increase above key resistance at $7 000 per ton.

• Gold has developed an inverse “head and shoulders” pattern, which indicates further upward momentum and a test of the $1 400 target level.

• The break in the JSE All Share index above key resistance levels at 56 000 and 60 000 signal the early stages of a new bull market.

Bottom line

• It is unlikely that Moody’s will downgrade South Africa’s local currency sovereign bonds to “junk” status. This is according to the bond market, the financial markets’ most reliable barometer.

• The sharp fall in South Africa’s country risk premium since President Zuma was defeated at the ANC elective conference tells a powerful story. The country risk premium is the spread between the 10-year South African government bond yield and the yield on the benchmark 10-year US Treasury bond, the so-called “risk-free” rate. The lower this spread the lower South Africa’s perceived country risk.

• South Africa’s country risk premium is back at levels last seen in the third quarter 2015 prior to Zuma’s firing of Finance Minister Nene. At that time, prior to subsequent credit rating downgrades, South Africa’s bonds were comfortably “investment grade”.

• The country risk premium has narrowed from a peak last month of 708 basis points to 582 basis points well below the pre-Nenegate level of 636 basis points. As encouraging as this may be the spread versus the US 10-year Treasury bond went as low as 233 basis points in 2006, well below today’s 582 basis points, indicating the potential for further substantial declines over coming months.

• The Budget speech, the State of The Nation Address, both in February, and Moody’s key credit rating decision in March, are likely catalysts for an additional reduction in South Africa’s country risk premium.

• The country’s risk premium has reduced in tandem with a steep appreciation in the rand. Given the potential for further substantial narrowing in the risk premium, the rand could appreciate considerably from current levels.

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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overberg asset management  |  sa economy

 
 
 
 

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