Cape Town - There is a probability of just 10% that the SA Reserve Bank (SARB) will hike the repo rate on Thursday, according to Overberg Asset Management (OAM) in its weekly overview of the economic and political landscape in South Africa.
According to the Forward Rate Agreement (FRA) market is pricing-in only 25 basis points of rate increases over the next nine months.
The overwhelming consensus is that SARB will keep the benchmark repo interest rate unchanged at 7.0% at its monetary policy meeting.
South Africa economic review
• The rand continued its gains for a third straight week, appreciating over the past week from R/$14.59 to 14.34, from R/€16.10 to 15.88, while weakening fractionally against the pound from R/£18.91 to 18.98. The rand also gained versus emerging market currencies, appreciating against the Argentinian peso (+2.5%), the Indian rupee (+1.9%), the Indonesian rupiah (+1.9%), the Philippian peso (+1.7%), Thai baht (+1.6%) and Singapore dollar (+2.0%).
The ten-year R186 government bond yield decreased slightly from 8.70% to 8.66%. Net foreign capital inflows into SA since the start of the year total R50bn, the largest cumulative inflow since 2012.
• Mining production increased in May by 2.5% month-on-month building on its solid 2.2% gain in April. Year-on-year growth was still negative at -4.4% but a substantial improvement on the -7.7% and -18.0% declines in April and March. The latest gain is attributed to the platinum group metals (PGM) sector, which increased production by 18.2% on the month.
However, much of the gains in PGM production may be due to stock-piling ahead of potential supply disruptions during current wage talks and may therefore not be sustainable. The wage talks themselves impose significant uncertainty over third quarter production.
• Manufacturing production grew by a robust 1.6% month-on-month in May building on the previous month’s 0.4% gain. On a year-on-year basis manufacturing growth increased from 3.1% in April to 4.0% the fastest rate since July 2015. This is well ahead of the 2.5% consensus forecast.
Out of the ten manufacturing categories only electrical machinery and food and beverages showed monthly declines. The data corroborates the recent uptrend in the Barclays manufacturing purchasing managers’ index (PMI), which has been above the expansionary 50-level for four straight months. The PMI increased from 51.9 in May to 53.7 in June signalling a continuation of the manufacturing recovery into the third quarter.
• Retail sales grew in May by a surprisingly strong 3.4% month-on-month more than reversing the -1.5% contraction in April. On a year-on-year basis retail sales grew by 4.5% up from 1.6% in April, the fastest growth rate since November 2012 and well above the 1.5% consensus forecast.
Among the retail categories, general dealers recorded an increase of 4.5% on the year, clothing and textile 6.0%, hardware and paint 7.5% and other retailers 11.4%.
The food, beverage and tobacco and household furniture categories suffered declines of -4.7% and -8.7%. While encouraging, the retail sales numbers contradict recent consumer-related data such as consumer confidence and household credit, which suggest the recent upswing is unlikely to be sustainable.
The week ahead
• Consumer price inflation (CPI): Due Wednesday 20th July. Having decelerated for three straight months CPI is expected to increase moderately from 6.1% in May to 6.3% in June according to consensus forecast.
While still above the SA Reserve Bank’s (SARB) 3-6% target range the medium-term outlook for inflation has improved due to the weaker oil price and stronger rand.
• SA Reserve Bank (SARB) Monetary Policy Committee (MPC) meeting. Due Thursday 21st July 2016. According to the Forward Rate Agreement (FRA) market there is a probability of just 10% that the SARB will hike the repo rate on Thursday.
The FRA market is pricing-in only 25 basis points of rate increases over the next nine months. (See Bottom Line for further analysis).
• The rand has rallied sharply following the Brexit vote and the ensuing likelihood that the Fed will refrain from hiking interest rates until 2017. The rand has strengthened below key resistance at R/$14.50 opening targets of R/$14.15 and R/$13.75. The rand is now comfortably below the 50-, 100- and 200-day moving averages. A sustained push below all three would indicate a major trend reversal.
• 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.
• Following the Brexit vote the British pound hit its weakest level against the US dollar since 1985. The £/$1.30 level provides key support, which if broken would open up a Fibonacci projected target of £/$1.20-1.24.
• 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 below key resistance levels of 1.6% confirming that the major bull trend in US bonds is likely to continue as the deleveraging phase is still in its early stages.
• The benchmark R186 SA Gilt yield has compressed to its lowest level since “Nenegate” last year falling below key resistance at 9.0%. The yield is now testing the bottom of the current consolidation channel at 8.5%, which if broken will target a yield of 8.0%.
• The MSCI World Equity index has broken downward from a rising trendline 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 between mid-2016 and mid-2017.
• The S&P 500 index has broken to new record highs but the rally is not being confirmed by momentum indicators, which suggests the market is overbought and in danger of correction. A further negative signal is that the Dow Jones Transport Index, traditionally a lead indicator for the broader market, is underperforming the broader index.
• Despite the recent price rally Brent crude’s break below the key $30 support level in February suggests a continuation of the weakening long-term trend to a downside $25 target. Copper is regarded a reliable lead indicator for industrial commodity prices and barometer of global economic growth.
Despite its recent rally the copper price broke below the key $4 500 support level in February suggesting further downside ahead.
• Gold has developed an inverse “head and shoulders” pattern, which indicates further upward momentum and a test of the $1 400 target level.
• The JSE All Share index is testing an important resistance line but if this remains unbroken the index is likely to move back below the 24-month moving average at 50 700 in turn opening a downside target of 45 000 and an ultimate target of 43 000.
The bottom line
• The overwhelming consensus is that the SA Reserve Bank (SARB) will keep the benchmark repo interest rate unchanged at 7.0% at its monetary policy meeting on Thursday.
• The stagflation conditions which afflicted markets earlier in the year, a combination of rising inflation at the same time as slowing economic growth, appear to be lifting. The outlook is improving: not only is economic activity increasing inflationary pressure and inflation expectations are declining.
• The economy has fared better since April. The data is consistent with second quarter GDP growth of 2.0% quarter-on-quarter annualised. Manufacturing output increased by a robust 1.6% month-on-month in May following growth of 0.4% in April, mirroring the substantial improvement over recent months in the Barclays’ manufacturing purchasing managers’ index (PMI).
The PMI has been above the key 50-level, which demarcates expansion from contraction, for four straight months rising from 51.9 in May to 53.7 in June. The mining sector has also improved with output rising 2.5% on the month in May following growth of 2.2% in April. Meanwhile, retail sales increased in May by a solid 3.4% on the month its fastest pace since November 2012.
• Consumer price inflation (CPI) has dropped for three consecutive months to 6.1% year-on-year in May, down from 6.2% in April and 6.3% in March, well below the 6.4% consensus forecast and down sharply from the 7.0% peak in February.
At the current rate CPI is almost back within the SARB’s 3-6% target range, while core CPI excluding food and energy prices, which tend to be more volatile, is already within range at 5.5%. Inflation expectations, as measured by the breakeven rate between conventional 1-year SA-government bonds and inflation-linked bonds of similar maturity, have dropped to 6.1% down from 7.5% in May.
• The deceleration in inflation is attributed to the decline in the oil price and especially the recent strength in the rand. Since the last SARB monetary policy meeting the rand has appreciated by around 10% versus the US dollar and around 11% against a trade-weighted basket of currencies.
• The rand’s strong rally has been boosted since the Brexit vote. In heightening global economic uncertainty, the Brexit vote has led the world’s major central banks to pledge additional monetary stimulus which in turn has aided substantial capital inflows into emerging markets in the search for yield.
The European Central Bank, Bank of England and Bank of Japan are expected to announce further interest rate cuts and increased quantitative easing. The Federal Reserve is no longer expected to hike its fed funds rate until the second half of 2017.
• The global search for yield has prompted significant inflows into SA. Net portfolio inflows since the start of the year total R50bn the largest cumulative inflow since 2012. The benefit for interest rates is clear. The forward rate agreement (FRA) market, is pricing-in only 25 basis points of rate increases over the next nine months.
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