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Blame for the rand’s sharp decline over the past month lies squarely with the Turkish lira and risk aversion caused by the Turkish currency crisis weighing on all emerging market currencies, according to to Overberg Asset Management (OAM).
And South Africa should not be confused with Turkey.
In its weekly economic and market overview, OAM noted the rand has declined by less than half the lira. While the Turkish currency had decreased by 23.9% against the US dollar over the past month, the rand had fallen by 9%.
"South Africa’s current account deficit, at 3.1% of GDP is less than half of Turkey’s 6.3% deficit. Most of South Africa’s debt is domestic with proportionately very little foreign currency debt. By contrast, Turkey is heavily dependent on foreign currency debt, especially in its banking sector."
"The rand’s recent period of volatility is likely to be brief. Besides the isolated Turkey-effect the global backdrop for emerging market currencies, generally, remains constructive."
South Africa economic review
• Mining production grew in June by a stronger than expected 2.8% year-on-year, beating the consensus forecast of a 0.8% contraction. Moreover, the previous month’s 2.6% contraction was revised upwards to a contraction of 1.8%. On a month-on-month basis, mining production increased in June by 5.0% while the previous month’s growth was upwardly revised from 5.0% to 5.9%.
By mining sector, the biggest contributors were the platinum group metals, which grew production by 28.2% on the year and diamonds, which grew by 18.7%. Iron ore grew 4.4%. The production of other base metals was flat to negative, while building materials contracted 14.5% on the year.
Gold production fell 19.2%. Over the second quarter (Q2), mining production increased 0.8% quarter-on-quarter, much improved from the 2.5% contraction in Q1, indicating a modest contribution to Q2 GDP growth. However, the outlook for the mining sector remains clouded by continuing domestic policy uncertainty and the effect of US trade protectionism on commodity prices.
• Retail sales growth slowed in June to a paltry 0.7% year-on-year down from 1.9% in May and well below the consensus forecast of 2.2%. On a month-on-month basis, retail sales fell in June by 1.2% reversing the previous month’s 0.9% growth, downwardly revised from an initial 1.1% expansion.
By retail sector, the standout contributors were household furniture, which increased 11.5% on the year and pharmaceuticals, which increased 5.3%. Over the second quarter (Q2) retail sales contracted by 0.4% quarter-on-quarter, which although less than the 1.5% contraction in Q1, does not bode well for Q2 GDP growth, especially with the manufacturing sector also contracting in Q2.
Even if GDP contracts by a modest 0.1% in Q2, South Africa will have entered a technical recession, defined as two consecutive quarters of contraction. Fortunately, the outlook for economic growth in the second half of the year is considerably brighter.
The week ahead
• Reserve Bank Composite Leading Business Cycle Indicator: Since peaking in February at its highest level since 2011, the Composite Leading Business Cycle Indicator, a key barometer of business and economic conditions 6-9 months ahead, has gradually eased backwards.
The Composite Leading Business Cycle Indicator will be closely monitored, providing an assessment of the economic outlook in the first half of 2019.
• Consumer price inflation: Consumer price inflation (CPI) has remained relatively unaffected by the VAT increase, and fuel and food price increases due largely to lacklustre domestic demand, making it difficult for producers to pass-on price increases.
Despite recent weakness in the rand, CPI will likely have remained below the key 5% level in July. Core CPI, which excludes fuel and food prices due to their volatility, will likely have remained unchanged.
Technical analysis
• The rand has retraced 50% of its 2016 to 2017 appreciation against the US dollar, indicating that the spike in the rand/dollar rate to R15.07/$ in mid-August may mark the peak in the currency’s recent decline.
• The rally in the US dollar index has reached its medium-term goal suggesting a correction from current levels. The dollar remains below a major 30-year resistance line suggesting the bull run in the dollar may be over.
• The British pound has broken back below key resistance at £1.35/$ suggesting a trading range of £1.30/$ to £1.35/$. The £1.28/$ level is expected to provide strong resistance.
• 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 is struggling to break decisively above key resistance at 3.0%. However, a break above this level is expected and would open the next target of 3.6%.
• The benchmark R186 2025 SA Gilt yield has retraced earlier weakness and fallen back below the key 9.0% level. A trading range of 8.4% to 9.0% is expected over the foreseeable future.
• 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 struggled to break above key resistance at $75 per barrel, indicating a likely trading range of $65 to $75 per barrel. The outlook for base metals prices is less certain after the copper price retreated sharply from the key $7 000 per ton level.
A decisive break below $6 000 per ton would herald a bear market in copper and base metals’ prices.
• Gold has developed an inverse "head and shoulders" pattern, which indicates a price recovery and a test of the $1 400 target level.
• Despite the consolidation since the start of the year the break in the JSE All Share index above key resistance levels at 56 000 and 60 000 in December signals the early stages of a new bull market.
Bottom line
• The rand’s turbulence over the past month is not an indication that the domestic economic outlook has deteriorated.
• Blame for the rand’s sharp decline over the past month lies squarely on the Turkish lira. Risk aversion caused by the currency crisis in Turkey has weighed on all emerging market currencies. South Africa should not be confused with Turkey. As the crisis originated in Turkey so the Turkish lira has been hardest hit. Over the past month the lira has sunk versus the US dollar by 23.9% and over three months and six months, by 32.7% and 57.3%, respectively.
The rand has declined by less than half the lira, by 9.0% over one month, and over three months and six months, by 14.9% and 25.2%. South Africa’s current account deficit, at 3.1% of GDP is less than half Turkey’s 6.3% deficit. Most of South Africa’s debt is domestic with proportionately very little foreign currency debt. By contrast, Turkey is heavily dependent on foreign currency debt, especially in its banking sector.
• As the world’s most liquid, easily traded emerging market currency, the rand always suffers the brunt of emerging market risk aversion. The rand, widely used as a hedging currency, is especially vulnerable to any shift in emerging market sentiment.
According to the Bank for International Settlements, the average single day’s turnover in rand trade is equivalent to around a third of South Africa’s total annual merchandise trade, by far the highest ratio of any emerging market currency, indicating the extent to which the rand is used for investment hedging and speculation.
• Emerging market sentiment can sour either due to a general deterioration in sentiment across all emerging markets emanating for instance from declining international commodity prices, rising US interest rates or a rapid decline in China’s economic growth, or due to a specific country event.
This has been the case over the past month with Turkey’s rapid decline in fortunes. Under President Erdogan, Turkey is veering towards escalating US sanctions and politically motivated monetary policy. Fortunately, the broader impact on emerging market currencies tends to be short-lived when there is an isolated culprit, like Turkey in this instance.
• The rand’s recent period of volatility is likely to be brief. Besides the isolated Turkey-effect the global backdrop for emerging market currencies, generally, remains constructive.
Commodity prices remain firm, buoyed by strong global economic growth, the Federal Reserve is approaching the peak in its interest rate hiking cycle, and China has begun to ease monetary policy, averting a significant slowdown in its economy.
• On a purchasing power parity basis, the rand is now undervalued, which suggests some appreciation over coming months.
Following recent rand volatility and the carry-yield (difference between domestic sovereign bond yields and US Treasury bond yields of similar maturity) the rand is now very cheap, close to equivalent levels reached following the 2008/09 global financial crisis.
• The rand’s recent decline is unlikely to prompt a shift in Reserve Bank monetary policy. There is little evidence of currency pass-through on domestic prices or inflation, especially in the current climate of lacklustre demand.
The Reserve Bank is likely to see past the rand’s recent volatility and maintain its course of mild monetary policy accommodation, keeping the benchmark repo interest rate unchanged for the foreseeable future.
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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