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Cape Town - The rand will benefit from a weak dollar and with it South Africa’s inflation trajectory and prospects for lower interest rates.
A weak dollar bodes well for South African equities, especially the resource sector in response to firmer commodity prices and domestically focused sectors most leveraged to a stronger rand and lower interest rates. The positive effects of a weak dollar are already evident.
This is the view of Overberg Asset Management in this week's overview of the economic landscape.
The rand has gained 2.0% against the US dollar since the start of the year, the SA Reserve Bank has begun easing monetary policy with its first 25 basis point repo rate cut on 21 July; the JSE Resources 20 Index has gained 10.69% in the past quarter in response to rising commodity prices; and the JSE All-share Index is not far behind with a gain of 4.19%.
South Africa economic review
• The ABSA manufacturing purchasing managers’ index (PMI) collapsed in July to 42.9 from 46.7 in June, well below the contractionary sub-50 level and its weakest since August 2009 at the height of the global financial crisis. The index was at an expansionary 51.5 as recently as May.
Among the PMI sub-indices, the business activity index, which measures output, fell from 45.4 to 39.3, while the new sales orders index fell from 43.7 to 39.8. There were some bright spots: The prices index remained unchanged at 61.3 indicating a stabilisation in inflationary outlook, while the forward looking expected business conditions index increased from 50.0 to 51.3. The PMI shock should be treated with some caution as it has tended to diverge significantly from actual production figures.
In the first quarter (Q1) the PMI averaged an expansionary 51.9 but manufacturing production fell in Q1 by 3.0% quarter-on-quarter annualised. In contrast the Q2 PMI averaged a contractionary 47.6 yet actual manufacturing production has rebounded and even with a slightly negative June reading remains on track to achieve annualised growth of over 6% in Q2.
• The Standard Bank composite purchasing managers’ index (PMI), measuring business conditions across all economic sectors, fared far better than the ABSA manufacturing PMI. The Standard Bank PMI increased from 49.0 in June to 50.1 in July regaining the key 50-level which separates expansion from contraction.
The PMI has averaged 50.3 year-to-date above the 2016 average of 49.7. Among the PMI sub-indices, the output index increased from 47.8 to 48.5, the employment index from 48.2 to 50.3, and the forward-looking new orders index from 49.0 to 50.8. At the same time, overall input costs decreased from 52.4 to 52.2 indicating an easing in inflationary pressure.
The leading PMI indicator, measuring the ratio of new orders to inventories, increased above 1.0 signaling a mild acceleration in production in the months ahead, which could build momentum if political and policy confidence is restored.
• Total new vehicle sales increased in July by a stronger than expected 4.1% year-on-year accelerating from 1.0% growth in June. While growth in commercial vehicle sales slowed from 5.5% to 0.2% passenger vehicle sales growth rebounded from -1.4% to 6.2% amid a sharp pick-up in demand from rental companies.
Vehicle export volumes increased 12.3% month-on-month to their highest since September 2015, lifting year-on-year growth from 1.3% to 22.2%. Vehicle sales appear to have turned the corner, helped by the favourable base effect of low year-ago comparative levels and the boost from lower interest rates.
• The Quarterly Labour Force Survey confirms that the unemployment rate remained unchanged from the first quarter (Q1) level of 27.7% in Q2, above the 27.5% consensus forecast and well above the Q2 2016 level of 26.6%.
The actual number of employed persons declined in Q2 by 113 000 with the construction sector shedding 110 000, followed by agriculture at 40 000, mining 13 000, transport 11 000, community 9 000, and private households 8 000. Among sectors adding jobs the trade sector added 58 000, finance 17 000, manufacturing 10 000 and utilities 2 000.
New entrants to the job market increased by 62 000 making it the biggest contributor to unemployment. The labour force participation rate, measuring the active portion of the economy’s labour force, fell from 60.5% to 59.9% indicating declining confidence in employment prospects.
Especially worrying, youth unemployment in the 15-24 age group, increased sharply from 54.3% to 55.9%. Jobs growth is unlikely to improve until political and policy confidence and business confidence are restored.
The week ahead
• The South African Chamber of Commerce and Industry (SACCI) business confidence index: Due on Tuesday 8th August.
The SACCI business confidence index, having unexpectedly gained from 93.2 in May to 94.9 in June is likely to gain further ground in July as survey respondents start to look past the current period of political uncertainty. The SACCI index has averaged 94 since the end of 2015.
• Manufacturing and mining production: Due on Thursday 10th August.
The June manufacturing and mining production figures will provide the final piece of the puzzle to the sectors’ respective contributions to second quarter (Q2) GDP. Due to rising year-ago base effects mining production growth is expected to fall from 3.6% year-on-year in May to 0.0% in June and the contraction in manufacturing production to deteriorate from -0.8% to -1.1%.
However, even if year-on-year growth in both sectors is slightly negative they will still contribute positively to Q2 GDP.
• Moody’s sovereign credit rating review: Due on Friday 11th August.
Moody’s cut both South Africa’s local and foreign currency credit ratings by one notch, although still in investment grade territory, following the ill-fated Cabinet reshuffle on 30th March. Since then the ratings have been on negative watch.
Moody’s is likely to wait until the Medium-Term Budget Policy Statement in October and the ANC elective conference in December before imposing any further rating downgrades.
Technical analysis
• The rand is testing key resistance at R/$13.00, which if broken would target further gains to R/$12.50 and thereafter R/$12.00.
• 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.
• Following the announcement of the snap election the British pound has broken above key resistance at £/$1.30 which has now become a key support level and should promote further near-term currency gains.
• 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% to 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, Nasdqaq 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 tonne.
• Gold has developed an inverse “head and shoulders” pattern, which indicates further upward momentum and a test of the $1400 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
• In the three years between January 2014 and January 2017 the US dollar was by a considerable margin the world’s best performing currency. Over the period the dollar index climbed from below 80 to above 103. The dollar was boosted by massive capital flight from the Eurozone and China in response to ECB quantitative easing and relaxation of capital controls in Beijing.
As the world’s first synchronised economic expansion since the 2008 to 2009 global financial crisis gains momentum and monetary tightening spreads from the Federal Reserve to other major central banks, capital flows to the US have begun to reverse. Capital outflows from the US will weaken the dollar.
• Political uncertainty stemming from Trump’s weak administration is likely to accelerate capital outflows from the US. The pool of potential outflows from the US is estimated at around $3trn. The Trump dollar could follow a similar path to the Carter dollar, which slumped between 1977 and 1981 in response to a lack of confidence in President Carter’s political leadership.
• Which asset classes will benefit from a weakening dollar? Demand for emerging market investments has surged since the start of the year correlating closely with the declining value of the US dollar. The MSCI Emerging Markey Index has risen 23.77% since the start of the year substantially ahead of the 12.37% gain in the MSCI World Index (both in dollars).
• A weak dollar is good news for commodity prices, emerging market shares and emerging market currencies. Hardly a week has gone by in recent months that dedicated emerging market equity and bond funds have not enjoyed sizeable inflows.
•The rand has gained 2.0% against the US dollar since the start of the year, the Reserve Bank has begun easing monetary policy with its first 25 basis point repo rate cut on 21st July, the JSE Resources 20 Index has gained 10.69% in the past quarter in response to rising commodity prices and the JSE All Share Index is not far behind with a gain of 4.19%.
• The promising turnaround in domestic market indicators is still in its early stages with solid prospects for further equity market gains as the dollar continues to depreciate.
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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