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Cape Town - Despite an improving outlook for the global economy the South African Reserve Bank's (Sarb) Monetary Policy Committee is near the peak in the interest rate cycle, said Overberg Asset Management (OAM) in its weekly overview of the SA economic landscape.
Sarb Governor Lesetja Kganyago may lean toward the possibility of interest rate cuts in the second half of the year premised on a stable rand, an absence of political tensions and a gentle trajectory in US rate increases, according to OAM.
Although CPI accelerated to 6.8% in December the pace of inflation is expected to return to the Sarb’s 3% - 6% target range by March 2017, said OAM.
South Africa economic review
• Total net foreign selling of bonds and equities since the start of the year amounts to R8.68bn, comprising R1.96bn bonds and R6.72bn equities.
In 2016 foreign investors sold a net R26.13bn in bonds and a massive R124.83bn in equities. Net foreign selling of equities has continued for 16 consecutive months since September 2015. A change in this trend should provide a solid indicator for the domestic equity market.
• Retail sales surprised on the upside in November rising 3.5% month-on-month and 3.8% year-on-year, well above the consensus forecast for a 0.4% decline on the year. Part of the surge may be attributed to increasing popularity of annual Black Friday sales.
Six out of the seven main retail categories made positive contributions with the strongest year-on-year gains in “food, beverages and tobacco”, “hardware, paint and glass” and “pharmaceuticals and medical goods, cosmetics and toiletries” at 6.0%, 5.8% and 4.8% respectively.
READ: Black Friday provides boost for SA retail sales
Consumer spending is likely to pick-up in the months ahead amid better economic growth prospects, declining inflation and the possibility of interest rate cuts in the second half of the year.
• Consumer price inflation (CPI) unexpectedly accelerated from 6.6% year-on-year in November to 6.8% in December well above the consensus forecast for a decline to 6.5%. On a month-on-month basis CPI increased 0.4%. The key culprits were food prices, which increased 0.8% on the month and 12.0% on the year, and housing and utility prices with housing rentals rising 1.4% on the month.
Meat prices increased 2.0% on the month as better rains encouraged livestock farmers to rebuild their herds. Core inflation, excluding food and energy prices, increased from 5.7% to 5.9%. Despite the recent uptick, CPI is expected to return to the South African Reserve Bank’s 3-6% inflation target by March this year helped by the base effect of high year-ago comparative figures and a steep decline in food prices.
In its latest report Agbiz estimates the total maize production in 2016/17 will be between 11.7 million and 13.0 million tons, well above last year’s 7.5 million tons and total domestic demand of 10.5 million tons.
• After recovering from -11 in the second quarter (Q2) last year to -3 in Q3 the FNB/BER consumer confidence index fell back to -10 in Q4. The index remains well below its +4 long-term average.
Among the three categories making up the index, the degree of confidence in economic prospects over the next 12 months and the household financial position over the next 12 months, fell the most from -4 to -23 and from +16 to +6, respectively.
READ: Consumer confidence dives as bleak outlook hits households
Pessimism was concentrated across the lower income groups, attributed to soaring food prices, weak household income growth and poor credit extension. Meanwhile, the durable goods index rebounded from -21 to -13 helped by significant discounting by durable goods retailers around annual Black Friday shopping.
The week ahead
• South African Reserve Bank (Sarb) Monetary Policy Committee (MPC) meeting: On Tuesday, January 24. The repo rate has remained at 7.0% since March 2016 and although consumer price inflation increased to 6.8% in December the Sarb decided to keep the benchmark interest rate on hold. (See Bottom Line for further analysis).
READ: AS IT HAPPENED: Kganyago leaves repo rate unchanged
• Leading economic indicator: On Tuesday, January 24. The South African Reserve Bank (SARB) leading economic indicator, which measures the expected economic outlook six to twelve months ahead, has increased steadily for four months in a row since July last year ending at 95.6 in November. This bodes well for economic improvement in 2017.
• Producer price inflation (PPI): Due on Thursday, January 26. According to consensus forecast PPI is expected to remain unchanged in December at November’s rate of 6.9% year-on-year despite the beneficial impact of better rains on agricultural prices. While the increase in food prices has abated energy prices have risen.
Technical analysis
• While the rand has broken below key resistance levels versus the dollar at R14.20/$ 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 key £1.30/$ support level has been broken opening up to a £1.20-1.24 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 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.
• 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 crude price is well supported at $40 a barrel and having broken key resistance at $50 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 $5000 per ton.
• 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 Sarb is forward-looking and so will be more mindful of the lower inflation rates around mid-year than current elevated levels.
At its policy setting meeting on Tuesday the Sarb kept the benchmark repo rate unchanged at 7.0% where it has been fixed since March 2016.
Despite an improving outlook for the global economy and a gradual acceleration in the pace of inflation in developed economies amid rising energy and commodity prices, the MPC is near the peak in the interest rate cycle.
According to the forward rate agreement market the probability of a 25 basis point rate hike on Tuesday was just 5% and in three months’ time it is just 13%. Weakness in key economic indicators supports the view that interest rates are unlikely to rise further.
• GDP grew in the third quarter (Q3) last year by just 0.2% quarter-on-quarter in stark contrast to the upwardly revised 3.5% in Q2. Mining output contracted in November by -4.2% year-on-year.
• Manufacturing output surprised to the upside with year-on-year growth of 1.9% but due mainly to export demand and seasonal factors.
• New vehicle sales contracted in December by -15.3% on the year and although retail sales grew in November by 3.8% on the year the trend remains subdued due to weakening consumer confidence. Growth in private sector credit extension slowed further to a multi-year low of 6.3% year-on-year.
• Financial markets are forward-looking and will start to discount rate cuts well before they happen. Further confirmation that interest rates have peaked and may fall towards year-end would provide positive momentum for both bond and equity markets.
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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