Despite global investor unease over emerging markets generally, foreign investors remain firm believers in South Africa’s New Dawn.
While global emerging market bond funds have suffered severe net investor outflows, the appetite for South African bonds remains steady.
"Net foreign inflows into South African bonds have risen steadily to a total of R24.58bn. Year-to-date net inflows into South African equities are even more impressive at R33.2bn," said Overberg Asset Management (OAM) in its weekly economic and market overview.
However, the analysts at OAM warn that sceptics of the New Dawn will point to the rand’s depreciation over the past month.
"Our currency has dropped 2.5% versus the US dollar over the period and at its low point had been down by as much as 5.5%.
"The rand’s recent drop has nothing to do with domestic developments and everything to do with dollar strength. All emerging market currencies have been affected."
South Africa economic review
• Manufacturing production unexpectedly shrank in March by 1.3% year-on-year (y/y) following a 0.6% contraction in February. On a quarter-on-quarter (q/q) basis manufacturing production contracted in the first quarter (Q1) by 1.7%, which indicates the manufacturing sector will have subtracted around 0.8 percentage points from Q1 GDP growth.
The worst performing manufacturing sub-categories in March were the textiles, clothing, leather and footwear sector, glass and non-metallic mineral products, and petroleum, chemical products, rubber and plastic products, which contracted y/y by 10.1%, 6.4% and 6.3% respectively. By contrast the motor vehicles, parts and accessories sub-sector grew by 6.4% on the year.
While manufacturing output slipped in March on a y/y basis, it grew on a month-on-month (m/m) basis by a solid 1.3%. Furthermore, the BER/ABSA manufacturing purchasing managers’ index regained the expansionary 50 level in April, indicating a lift in the manufacturing sector in Q2 and into the second half of the year.
• Mining production fell sharply in March by 8.4% y/y following a 2.0% decline in February, far worse than the consensus forecast for a 0.2% increase. On a q/q basis mining production fell by 2.5% kin Q1, which indicates the mining sector will have subtracted around 0.7% from Q1 GDP growth.
The decline was broad-based. Among mining sub-categories, diamonds contracted 24.7% on the year, followed by gold which declined 18%, metallic minerals 17.5%, building materials 17.4%, iron ore 8.9% and platinum group metals 6.1%. The immediate outlook for mining production is overshadowed by the 3.4% m/m decline in March.
However, conditions are expected to improve into the remainder of the year helped by rising domestic demand and as the base effect of high year-ago production data falls away. In addition, the longer-term outlook is brightened by the combination of buoyant international commodity prices and the imminent resolution of uncertainties surrounding the Mining Charter.
The week ahead
• Quarterly labour force survey: The country's unemployment rate remained unchanged at 26.7% over Q1 2018 compared to Q4 of 2017, according to the quarterly labour force survey released by Statistics South Africa on Tuesday.
• Retail sales: Retail sales growth may have slowed from 4.9% y/y in February to 4.4% in March according to consensus forecast, although momentum should remain positive as indicated by an extremely strong FNB/BER consumer confidence reading. The consumer confidence reading increased in the first quarter to its highest in 36 years.
• Having broken the key resistance levels at R12.50/$, the rand has returned to its appreciating trend, targeting a break below R11.00/$ over coming months.
• 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 £1.35/$, promoting further near-term currency gains to a target range of £1.40/$ to -£1.50/$.
• 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 decisively above key resistance at 2.5%, targeting the next key resistance level at 3.0%. A break above long-term resistance at 3.6% would indicate an end to the multi-decade bull market in bonds.
• The benchmark R186 2025 SA Gilt yield has broken below key resistance at 8.6%%, indicating a new target trading range of 8.0-8.5%.
• 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 $70 and is likely to remain in a trading range of $65 to $75 over the foreseeable future. Base metal prices are in a bull trend confirmed by copper’s increase above key resistance at $7 000 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 in the JSE All-Share index above key resistance levels at 56 000 and 60 000 signals the early stages of a new bull market.
• Sceptics of South Africa’s New Dawn will point to the rand’s depreciation over the past month. Our currency has dropped 2.5% versus the US dollar over the period and at its low point was down by as much as 5.5%.
• The rand’s recent drop has nothing to do with domestic developments and everything to do with dollar strength. All emerging market currencies have been affected. The JP Morgan Emerging Market Currency Index has declined 7% from its peak in February.
Rising US Treasury bond yields and the strengthening US dollar have lessened the attraction of emerging market bonds and the so-called carry trade. The JP Morgan Emerging Market Bond Index (EMBI) is at its lowest since February 2016, when global anxiety was centred on Chinese currency devaluation. The EMBI has dropped by 8.3% since the start of the year.
• How has the rand fared against other emerging market currencies? The local unit has outperformed with flying colours. Since the start of the year, the rand has firmed versus the US dollar by 0.6%, despite the demanding starting point following the 15% appreciation in the last six weeks of 2017.
By contrast, since the start of the year the Brazilian real, Indian rupee, Indonesian rupia and Korean won have dropped by 7.3%, 5.1%, 3.4% and 0.3%, respectively.
The outliers, the Argentinian peso and Turkish lira, have fallen in dramatic fashion by 16.4% and 11.2%. The Mexican peso, helped by a more conciliatory US approach towards NAFTA trade talks, is one of the very few to have fared better than the rand with a gain versus the dollar of 1.4%.
• Despite global investor unease over emerging markets generally, foreign investors remain firm believers in South Africa’s New Dawn. While global emerging market bond funds have suffered severe net investor outflows, the appetite for South African bonds remains steady. The bellwether R186 bond yield has strengthened in the year-to-date (YTD) from 8.59% to 8.35%.
Net foreign inflows into South African bonds have risen steadily to a YTD total of R24.58bn. YTD net inflows into South African equities are even more impressive at R33.2bn.
• South Africa’s vulnerability to external financial shocks has reduced in line with an improvement in its twin deficits, the budget deficit and current account deficit. The budget deficit is projected to fall steadily over the next three years in line with stronger economic growth and more stringent expenditure controls.
The current account deficit is forecast to reduce to 2.8% of GDP in 2018, below the average of 3.5% over the past ten years and well below the 6.0% peak in 2013.
• Moreover, there are a series of potentially positive events which will likely underpin the rand over coming months.The ongoing “re-capture” of the state’s financial institutions and state-owned enterprises followed by bolder structural reforms will provide a steady stream of positive events for the rand.
• Blame for emerging market currency weakness generally is being lodged squarely at the doorstep of the US Federal Reserve. Dollar strength is attributed to falling global dollar liquidity growth, which stems from the Fed’s steepening trajectory of interest rate hikes.
• Fed chairperson Jay Powell points out, however, that emerging markets can accommodate a normalisation in US monetary policy, noting that inflows have been rising steadily since the Fed started to taper its quantitative easing programme in 2015. He adds that emerging markets have made “Considerable progress in reducing vulnerabilities since the crisis-prone 1980s and 1990s….
"Many have substantially improved their fiscal and monetary policy frameworks while adopting more flexible exchange rates, a policy that recent research shows provides better insulation from external financial shocks.”
It is noteworthy that global dollar liquidity growth, while slowing, remains firmly in positive territory. It is unlikely that a protracted flight from emerging market assets will take hold while global dollar liquidity growth remains positive.
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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