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Rand 'mauled' in reshuffle aftermath

Apr 11 2017 16:02

Cape Town  The rand has been mauled in the aftermath of President Zuma’s Cabinet reshuffle, and has since lost 11% versus the US dollar and 9% on a trade-weighted basis, said Overberg Asset Management (OAM) in its weekly overview of the SA economic landscape.

It noted that the rand will likely maintain its downward trajectory as the inability of the ANC to remove Zuma post the cabinet reshuffle heightens the political-economic risks.

South Africa economic review

• The rand was mauled for a second straight week. Having dropped by 7.3% against the US dollar in the week of President Zuma’s ill-fated cabinet reshuffle the rand fell by a further 3% in the past week from R/$13.41 to 13.80. Against other currencies the rand fell from R/€14.34 to 14.65 and from R/£16.77 to 17.10.

Bond yields also climbed higher pushing the yield on the benchmark R186 2025 from 8.84% to 9.0%. In the month of March foreign investors purchased a net R18.6bn worth of domestic bonds taking the year-to-date figure to R18.1bn.

Unfortunately, the positive inflows for the year-to-date are likely to unravel and turn negative over coming weeks in response to credit rating downgrades. (See Bottom Line for further analysis).

Meanwhile, foreign investors continued to dump domestic equities even prior to the cabinet reshuffle, selling a net -R40.3bn in the year-to-end March following total net sales of -R124.8bn in 2016. The trend is expected to persist in 2017.

• Standard & Poor’s Global (S&P) downgraded South Africa’s long-term foreign currency credit rating to BB+, a sub-investment or so-called “junk” grade. The long-feared move did not come as a surprise following President Zuma’s firing of former finance minister Pravin Gordhan and his deputy Mcebisi Jonas.

According to S&P: “The divisions in the ANC-led government that have led to changes in the executive leadership, including the finance minister, have put policy continuity at risk.” The consequences of the credit rating downgrade will be higher borrowing costs for all South African persons, a weaker exchange rate, higher inflation, lower investor confidence and slower economic growth. S&P kept the credit rating on negative watch for further downgrades should the current policy path alter.

• Fitch Ratings cut South Africa’s long-term credit ratings to sub-investment grade or so-called junk level for both foreign and local currency debt. Fitch has become the first of the rating agencies to assign junk status to local currency debt. It takes two such ratings for South Africa’s local currency debt to be dropped from international bond indices.

Being dropped from international bond indices would result in forced bond selling. 90% of South Africa’s debt is local currency denominated. In Fitch’s statement: “Recent political events, including a major cabinet reshuffle, will weaken the standards of governance and public finances.” Fitch reported that the Treasury’s ability to withstand spending demands from state-owned companies and government departments could weaken and that the nuclear programme is now likely to proceed relatively quickly.

• Total new vehicle sales increased in March by 2.1% year-on-year rebounding from February’s 0.1% decline. This marks the second year-on-year gain this year following the 3.7% increase in January. For the first quarter (Q1) of 2017 total vehicle sales increased by 1.9% on the year the first quarterly gain since Q4 2014.

For the quarter, sales of passenger vehicles increased 0.9% and commercial vehicles by 4.2%. According to Rudolf Mahoney, head of Brand and Communications at WesBank: “March’s sales performance is indicative of the positive sentiment in the economy during the past month. There were a few contributing factors, including a strong rand and falling fuel prices.”

However, this positive outlook will be short-lived following the credit rating downgrades and the knock-on effect on business and consumer confidence.

• The Absa manufacturing purchasing managers’ index (PMI) declined slightly from 52.5 in February to 52.2 in March but remained above the expansionary 50-level for the third straight month. For the first time since March 2012 all major PMI sub-indices were above the neutral 50-level.

The business activity index gained from 53.2 to 53.5 and the employment index from 46.5 to 50.9 while the purchasing price index fell from 68.0 to 63.5 helped by the disinflationary effect of the stronger rand. The forward-looking expected business conditions index, measuring expected conditions in six months’ time, increased from 67.8 to 68.0.

The unequivocally positive outlook reflected in the manufacturing PMI data was captured prior to Zuma’s firing of former finance minister Pravin Gordhan and his deputy Mcebisi Jonas. The outlook is likely to deteriorate sharply in the April PMI readings.  

The week ahead

• Manufacturing production: Due on Tuesday 11th April. Manufacturing production is expected to show a modest improvement in February in line with the recovery in the manufacturing purchasing managers’ index (PMI). The PMI averaged 51.7 in January and February up from just 47.0 in December. A reading above the 50-level signals expansion.

• Retail sales: Due on Wednesday 12th April. Having contracted in December and January retail sales are expected to show a further negative reading in February. Consumer confidence remains weak amid poor jobs growth and record low credit extension figures.

• Mining production: Due on Thursday 13th April. Mining production is expected to respond favourably to rising commodity prices and the base effect of weak comparative data. Having contracted in 2016 as a whole by 4.9%, mining production is projected to return to positive growth in 2017.

Technical analysis

• The rand has depreciated below key support at R/$13.50 paving the way for further depreciation. The next key support level is at R/$14.0 which if broken will likely prompt a rapid decline to R/$14.50.

• 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 key £/$1.25 level support level has been broken opening up a £/$1.18-1.22 target.

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

• The benchmark R186 2025 SA Gilt yield has broken above the key support level of 9.0% suggesting the mini-bull market in bonds is likely over. A break above 9.50% would likely prompt a further upward move to the 10.5% level.

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

• The Brent crude price is well supported at $50 a barrel and having broken key resistance at $55 is targeting further gains to the next key level at $60. Base metal prices are in a bull trend confirmed by copper’s increase above key resistance at $5500 per ton.

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

•  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 economy has consistently faltered under President Zuma’s tenure. In 2017 per capita GDP is expected to decline for a fourth year running with population growth continuing to exceed economic growth.

While Zuma’s second term has been especially negative for the economy the downward trend has been visible since he first took office in 2009. In every year since 2009 South Africa’s per capita GDP has decreased as a percentage of world per capita GDP. Standing at a reasonably proud 93.4% in 2008 the statistic fell steadily to just 84.1% in 2015.

• Unfortunately, the rand will likely maintain its downward trajectory of the past 10 days. The inability of the ANC to remove Zuma post the cabinet reshuffle heightens the political-economic risks in the run-up to the party electoral conference in December. The results of last week’s ANC’s National Working Committee (NWC) meeting suggest Zuma’s hold on the party has strengthened. His opponents within the party have backed down and the NWC has stated that ANC members will not support the motion of no confidence on the 18th April.

•    While both Standard & Poor’s (S&P) and Fitch have downgraded South Africa’s foreign currency credit rating to below investment grade Fitch is the only rating agency to cut the local currency rating to junk level. The local currency rating is more critical as 90% of the country’s debt is raised in the local markets. For South Africa’s local currency bonds to be jettisoned from the World Global Bond Index would require at least two rating agencies to downgrade the local currency rating to junk status. The chances are high: Moody’s rating agency has put South Africa on review for a downgrade and S&P has South Africa on “negative watch”. While Moody’s is still two notches above junk status there are precedents for a two-notch downgrade, as occurred in Brazil in February 2016.

•    The catalyst for further downgrades in the local currency credit rating will likely come from the Treasury. Finance Minister Malusi Gigaba has maintained the culture of patronage by bringing with him to the National Treasury 16 officials from the Department of Home Affairs.

•    It is only a matter of time before the new finance minister rubber stamps Eskom’s proposed 9,600 megawatt nuclear programme. In its recent downgrade Fitch stated that the nuclear programme is now likely to move “relatively quickly”.

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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