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Cape Town - The combination of weak economic growth, tame inflation, and a positive global economic backdrop support the case for an interest rate cut, said Overberg Asset Management (OAM) in its weekly economic overview.
The consensus view is that the repo rate will be cut on Thursday by 25 basis points, OAM said. "There is a reasonable possibility that the rate cut will be even deeper at 50 basis points."
OAM also noted that the South African Reserve Bank (SARB) may be tempted to bring forward the expected additional end-of-year rate cut due to event risks such as potential fiscal negligence at the Medium-Term Budget Policy Statement in October, credit rating reviews in November and the ANC elective conference in December.
South Africa economic review
• The RMB/BER Business Confidence Index, after collapsing from 40 to 29 in the second quarter (Q2) regained some ground to 35 in Q3 albeit well below the neutral 50-level which demarcates expansion from contraction. This indicates that 65% of the 1600 senior executives surveyed maintained a negative outlook.
Not a single business sector achieved a reading above the key 50-level, reflecting weakness in domestic demand, business activity and investment. The survey cited concerns over low profitability in the current environment of political and policy uncertainty.
Among the business sectors, the building sector gained from 36 to 44, retail from 35 to 38, manufacturing from 16 to 27, new vehicle dealers from 11 to 19, while wholesale was relatively firm although dipped from 49 to 48. Business confidence is unlikely to recover sustainably until there is clear direction from policy makers.
• The South African Reserve Bank (SARB) Quarterly Bulletin reveals a surprise deterioration in the current account deficit in the second quarter (Q2). Despite a third consecutive quarterly trade surplus the current account deficit increased from 2.0% of GDP in Q1 to 2.4% in Q2. Exports grew in Q2 by 4.6% quarter-on-quarter while imports grew by 4.2%.
However, service and income receipts shrank by 6.2% while political and policy uncertainty prompted a R26bn decline in net direct investment. While negative investment outflows will continue to detract from progress made on the trade balance, the current account deficit is nonetheless expected to improve from 3.3% in 2016 to 2.6% in 2017. The improving current account deficit should provide some protection for the rand, in turn facilitating a further easing in monetary policy.
• The South African Reserve Bank (SARB) Quarterly Bulletin revealed some good news for households. Household real disposable income increased in the second quarter (Q2) by 4.5% quarter-on-quarter more than reversing the 2.1% contraction in Q1. Debt to disposable income eased from 73% to 72.6% as households continued to improve their balance sheets.
While the household debt service cost as a percentage of disposable income remained unchanged at 9.4% this is expected to improve as the SARB delivers further interest rate cuts. Household disposable income should gradually increase over coming quarters amid lower inflation and falling interest rates.
• Retail sales grew year-on-year for a fifth consecutive month increasing in July by 1.8% albeit down from June’s upwardly revised 3.2% growth. Food sales increased 7.1% while pharmaceutical sales grew 5.1% after contracting 0.9% in June.
Textile sales growth slowed from 4.5% to 1.2% while durable goods sales growth rebounded to 4.5% after contracting by 0.4% in June with furniture and hardware sales rising 6.8% and 2.8% respectively. There appears to be some relief for consumers with declining inflation and lower interest rates expected to add further support over coming months.
• An easing in global geopolitical tensions and recovery in demand for emerging market assets prompted strong net inflows into South Africa’s bond market in the past week. Foreign investors purchased a net R7.4bn worth of bonds in the week ended 15th September the biggest weekly inflow in seven weeks.
By contrast, foreign investors were net sellers of R4.7bn of equities. For the month-to-date foreigners have purchased a net R13.7bn in bonds but sold a considerable R19.8bn in equities. Respective year-to-date balances are R66.1bn in bond inflows and R65.2bn in equity outflows resulting in a slender aggregate net inflow of R0.9bn.
The week ahead
• Consumer price inflation: Released on Wednesday, 20 September.
Stats SA announced on Wednesday that consumer inflation has gone up, but slightly below market expectations, following increases in the fuel price. South Africa's Consumer Price Index (CPI) annual inflation rate increased to 4.8% in August from 4.6% in July. On average, prices increased by 0.1% between July 2017 and August 2017. The market was expecting a "fuel price-induced jump to 4.9%".
The CPI is still within the SA Reserve Bank's 3% to 6% target band, and TreasuryOne said after the CPI release that there is a "good chance the SARB may look to cut interest rates tomorrow by another 25 basis points".
• Reserve Bank Monetary Policy Committee meeting on Thursday, 21 September.
Prompted by weak economic growth, and helped by tame inflation and a constructive global backdrop, the South African Reserve Bank is expected to cut its benchmark repo rate by a further 25 basis points. (See Bottom Line for further analysis).
Technical analysis
• The rand needs to break through key resistance at R/$13.00/$, which if broken would target further gains to R12.50/$ and thereafter R12.00/$.
• The US dollar index has tried but failed to break through a major 30-year resistance line suggesting the three-year bull run in the dollar may be over.
• The British pound has broken above key resistance at £1.30/$ promoting further near-term currency gains to a target range of £1.35-1.40/$.
• 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 is trading in a tight trading range of 8.5-9.0%. A break above 9.0% is required for the yield to move decisively higher towards the 10.5% target level.
• 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 $50 and likely to remain in a trading range of $50 to $60 over the foreseeable future. Base metal prices are in a bull trend confirmed by copper’s increase above key resistance at $6 000 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 above 54 200 on the JSE All-share index projects an upward move to 60 000 marking a new high for the JSE.
Bottom line
• The South African Reserve Bank (SARB) Monetary Policy Committee marked the start of its rate cutting cycle on 20 July, reducing the repo rate by 25 basis points from 7.0% to 6.75%. The forward rate agreement market is currently pricing in an 81% probability of a further rate cut on Thursday when the SARB concludes its September policy meeting. The combination of weak economic growth, tame inflation, and a positive global economic backdrop support the case for a rate cut.
• Despite the rebound in GDP growth in the second quarter, economic momentum remains stagnant. Economic surveys, including purchasing managers’ indices, confidence measures and the SARB leading economic indicator, all point to lacklustre conditions.
The SARB has lowered its 2017 GDP forecast from a previous 1.0% to 0.5% and for 2018 and 2019 from 1.5% to 1.2% and from 1.7% to 1.5%. In July’s policy meeting the SARB adopted a slight shift in emphasis from inflation to growth, which given its deteriorating growth forecasts raise the likelihood of continued monetary easing.
• The SARB’s inflation forecasts have been revised lower. The SARB’s consumer price inflation forecasts for 2017, 2018 and 2019 have declined from a previous 5.7%, 5.3% and 5.5% to 5.3%, 4.9% and 5.2% respectively, well within its 3 % - 6% target range. Food price disinflation is expected to continue as previous drought conditions normalise.
• Oil prices will remain under pressure amid the global supply glut. Inflation will benefit from the lagged effect of the rand’s appreciation over the past 18 months. Administered price inflation is showing a considerable slowdown with NERSA granting Eskom an annual price increase of just 2.5%. The SARB noted some moderation in average salaries and wages, which are expected to remain below 6% over the 2017-2019 forecast period.
• The global environment supports a rate cut. Synchronised global economic growth is driving strong investor demand for emerging market assets. The favourable global outlook should fuel continued appreciation in emerging market currencies, facilitating further monetary policy easing in these economies.
• The consensus view is that the repo rate will be cut on Thursday by 25 basis points. There is a reasonable possibility that the rate cut will be even deeper at 50 basis points. The SARB may be tempted to bring forward the expected additional end of year rate cut due to once-off event risks later in the year.
These event risks include potential fiscal negligence at the Medium-Term Budget Policy Statement in October, credit rating reviews in November and the ANC elective conference in December.
• The prospect of lower interest rates is driving equity markets higher. Lower interest rates are unequivocally good news for the All-share index. Lower interest rates will lead to higher intrinsic equity valuations, to capital transfers from money markets into equities, and will boost economic growth prospects and company earnings.
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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