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Cape Town - Contrary to the Sarb’s best intentions the rate hike is bad news for the rand, says Overberg Asset Management (OAM) in its weekly overview of the SA economic landscape.
According to OAM slower economic growth will affect company earnings growth in turn provoking greater net foreign selling of domestic equities.
"Far from rescuing the rand the latest interest rate hike raises the likelihood of SA losing its investment grade rating and with it the mandate for foreign institutional investors to invest in the country."
Higher interest rates will aggravate an already perilous situation by lifting the cost of investment and placing household disposable income under further pressure, increasing the probability of outright recession, OAM said.
• As expected the SA Reserve Bank (Sarb) hiked its benchmark repo rate by 50 basis points from 6.25% to 6.75% taking the prime lending rate from 9.75% to 10.25%. The decision was not unanimous: Among the six members of the Sarb Monetary Policy Committee (MPC) three favoured a 50 basis point hike, two favoured 25 basis points and the remaining member argued for no change.
Sarb Governor Lesetja Kganyago acknowledged that although the weaker rand had so far shown little sign of being inflationary renewed rand weakness and the effect of the drought raised the risk of spillover effects from the depreciating currency. The Sarb revised its GDP forecasts lower for 2016 and 2017 from a previous 1.9% and 2.1% to 1.5% and 1.6% respectively.
The inflation forecast for 2016 and 2017 deteriorated significantly from a previous 6.0% and 5.8%, to 6.8% and 7.0% well above the central bank’s 3-6% target range. (See “Bottom Line” for further analysis).
• The trade surplus increased more than expected from R1.8bn in November to R8.22bn in December. Although well above the R4.7bn consensus forecast the December figure is often distorted by a lack of imports during the festive season. The improvement is attributed to the effect of the weaker rand on imports which fell -13.3% month-on-month while exports fell by -5.1%.
Among the main export categories exports of precious stones increased 21.5% on the year, and vehicles and transport equipment by 9.6%. Imports were dragged lower by a -21.8% decline in mineral products which mainly comprises oil. The cumulative trade deficit reduced from –R82.27bn in 2014 to –R48.63bn in 2015. The outlook will depend on a recovery in commodity prices and improvement in global demand for SA’s manufacturing exports.
• Growth in private sector credit extension (PSCE) increased from 9.5% year-on-year in November to 10.3% in December beating the 9.8% consensus forecast. Credit extended to households slowed from 4.6% to 4.5% but the slowdown was made up by corporate credit extension which increased from 13.8% to 14.1%.
Although encouraging the pick-up in overall credit extension is unlikely to be sustained in the low growth environment and amid rising interest rates. The Reserve Bank is expected to hike the benchmark interest rate by a further 75 basis points on top of the 50 basis point rate increase last week.
• Producer price inflation (PPI) accelerated from 4.3% year-on-year in November to 4.8% in December slightly below the 4.9% consensus forecast. The food products, beverages and tobacco products category increased 6.2% on the year adding 2.1 percentage points to the overall PPI measure.
With food products making up 25.2% of the overall PPI basket the impact of the drought is likely to contribute to a pick-up in inflationary pressure over coming months. However, some relief may be in store with the department of agriculture upgrading its estimate for summer maize production from a previous 5.5 million tonnes to 7.4 million. Among other PPI categories the increase in electricity and water prices accelerated from 12.9% year-on-year to 14.1%.
• The Barclays manufacturing purchasing managers’ index (PMI) stayed below the key 50 level, which separates expansion from contraction, for a sixth straight month falling from 45.5 to 43.5. Among the PMI sub-indices the business activity index fell from 42.4 to 37.5, the forward-looking new sales orders index from 44.8 to 40.1, and the expected business conditions from 46.1 to 39.4, all at their lowest levels since the 2008/09 recession.
Comprising numerous lead-indicator sub-indices the PMI is particularly concerning and indicates the manufacturing sector is likely to contract in the first quarter 2016. At the same time inflationary pressures mounted up pushing the prices sub-index from 77.2 to 86.0.
• New vehicle sales fell in January by -6.9% year-on-year extending the -4.0% decline in 2015. The outlook remains uncertain with the latest BER retail survey showing new car dealers expect a deterioration in sales in the first quarter. The National Association of Automobile Manufacturers (Naamsa) forecasts total vehicle sales will contract in 2016 by 3-5%.
Passenger vehicle sales, which shrank in January by -6.1% on the year will be under pressure from tightening credit standards and declining household disposable income. Growth in credit extended for vehicle purchases has fallen steadily to 3.7% year-on-year in contrast to double digit growth rates in 2014. Commercial vehicle sales, which shrank in January by -8.9% on the year reversing the previous month’s gain, will be constrained by weakening business confidence and delays in public sector infrastructure spending.
SA political review
• Finance Minister Pravin Gordhan and senior National Treasury colleagues met with a large group of senior business executives from the private sector to discuss ways for averting a sovereign credit rating downgrade. The meeting should be viewed positively. There is a growing urgency to build better communication and lines of cooperation between the government and private sector.
The meeting also signals government’s acknowledgement of the severity of the current crisis and that an economic recession and credit rating downgrade could be imminent realities. This acknowledgement was mirrored by ANC Secretary General Gwede Mantashe who admitted after the recent ANC National Executive Committee lekgotla that “everything” must be done to avoid an economic recession.
While the more business- and market-friendly proposals are encouraging there is no doubt that in the run-up to the local elections the ANC will reiterate its commitment to radical populist policies, which may contradict recent initiatives.
The week ahead
• Gross reserves: Due Friday 5th February. Gross reserves are expected to increase marginally from $45.79bn in December to $45.83bn in January due to the upward valuation in the dollar gold price and revaluation adjustments stemming from the stronger euro.
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 little sign so far 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 broke out of its long-term bull trend as a result of “Nenegate”. The new bear trend for the R186 is underpinned by resistance at 9.0% with a risk of further upside to 10.50%. While SA bond yields may fall in line with global bonds they are unlikely to return to the bull trend.
• The MSCI World Equity index has broken downward from a rising wedge formation 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 around June 2016.
• The S&P 500 index has broken downward from a rising wedge pattern, which is traditionally a trend-changing pattern. The downward trend is likely to remain intact unless the index decisively regains the 2070 level. 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 $30 support level suggests a continuation of the weakening long-term trend to a downside target of $25. Copper is regarded a reliable lead indicator for industrial commodity prices and barometer of global economic growth. It has broken below the key $4 500 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 JSE All Share index remains below the 24-month moving average at 50 600. The recent consolidation pattern between 47 000 and 49 000 is likely to be resolved with a break to the downside to an initial target of 45 000 and an ultimate target of 43 000.
Bottom line
• The SA Reserve Bank (Sarb) hiked the benchmark repo interest rate by 50 basis points from 6.25% to 6.75% in turn pushing the Prime rate higher from 9.75% to 10.25%. The central bank cited inflation as the main reason for the sharp interest rate hike, which was far larger than the recent pattern of gradual 25 basis point increases.
• For some time the Sarb has warned that it would stick to its core mandate of “price stability” so given the rapid deterioration in its consumer price inflation forecast since the last policy meeting in November the large rate hike should not come as a surprise. The Sarb’s previous consumer price inflation forecasts for 2016 and 2017 of 6.0% and 5.8% have surged in the past two months to 6.8% and 7.0% respectively. These figures are well above the Sarb’s 3-6% target range.
• Why have the CPI forecasts increased so sharply? Drought induced food price inflation, the sharp increases in administered prices such as water and electricity tariffs, and persistently high wage agreements, have remained relatively constant since the last Sarb policy meeting. The biggest scare for CPI forecasts is the rapid depreciation in the rand which just prior to last week’s monetary policy meeting had depreciated versus the dollar by a massive -16% in just two months.
• The Sarb believes that the large interest rate hike will limit the rand’s rate of depreciation by narrowing the interest rate differential between SA and the US. The initial reaction in foreign exchange markets was positive. The rand strengthened from R/$16.39 the day before the rate hike to R/$15.85 by the weekend two days later, a gain of almost 3.5%.
However, part of the rand’s appreciation can no doubt also be attributed to increased global risk appetite when the next day the Bank of Japan’s announced a surprise interest rate cut and boosted its quantitative easing programme. Sadly the rand’s moment in the sun has been short-lived with the rate back at R/$16.07.
• The irony is that contrary to the Sarb’s best intentions the rate hike is bad news for the rand. Slower economic growth will affect company earnings growth in turn provoking greater net foreign selling of domestic equities.
• Standard & Poor’s has cited weakness in GDP growth as their main concern due to the impact this would have on an already stretched Budget deficit. As the Treasury turns to the capital markets to plug the widening Budget deficit, SA’s debt to GDP ratio will rise. Far from rescuing the rand the latest interest rate hike raises the likelihood of SA losing its investment grade rating and with it the mandate for foreign institutional investors to invest in the country.
• The Sarb itself reduced its forecast for GDP growth for 2016 and 2017 from a previous 1.5% and 2.1 % respectively to just 0.7% and 1.6%. Higher interest rates will aggravate an already perilous situation by lifting the cost of investment and placing household disposable income under further pressure, increasing the probability of outright recession.
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* 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.
