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Rand weakens despite interest rate hikes

Cape Town - The hope that higher interest rates will lure foreign bond investors may be based on flawed thinking, says Overberg Asset Management in its weekly overview of the SA economic landscape.

"Since the start of the year foreign investors have been far more focussed on equity investment than bond investment with net equity inflows of R35.89bn over the period compared with equivalent inflows of just R18.74bn into local bond markets," OAM said.

"The Sarb should be focussing on making the equity market more attractive to foreign investors. However, higher interest rates will further weaken an already anaemic economic growth and profit outlook."

Instead of strengthening after the interest rate hike the rand has been the second weakest performer (after Brazil) out of all emerging market currencies falling from R/$12.35 to R/$12.65, a fall of almost 3% in just two trading days.

According to OAM rand hedge stocks should continue to outperform, with the rand expected to depreciate further despite the best intentions of the Sarb.

South Africa economic review

• Consumer price inflation (CPI) picked-up slightly from 4.6% year-on-year in May to 4.7% in June well below the 5.0% consensus forecast. The higher CPI reading is attributed to the 3.7% increase in fuel prices in June. Besides fuel there was little sign of rising inflation with food price inflation unexpectedly falling from 4.7% in May to 4.3% in June. Encouragingly core CPI, which excludes energy and food prices, eased from 5.7% to 5.5% its lowest level since May 2014. The subdued core CPI reading signals an absence of “demand-driven” inflationary pressure: Vehicle price inflation fell from 4.3% to 4.1% the lowest since December 2013 and services price inflation fell from 5.9% to 5.6% the lowest since December 2011, both indicating a weak demand environment.

• In spite of weaker than expected consumer price inflation the SA Reserve Bank (Sarb) hiked interest rates lifting the repo rate from 5.75% to 6.0% marking the first rate increase since July 2014. The Sarb Monetary Policy Committee decision was not unanimous with four of the six-member committee voting in favour and two against the rate hike. Sarb Governor Lesetja Kganyago cited concerns over the inflation trajectory due to the influence of higher maize prices and the impact of a weaker rand. The rate hike was implemented despite the National Energy Regulator of SA (Nersa) rejecting Eskom’s electricity tariff increase and despite the recent sharp decline in the oil price. The rate hike appears to have been most influenced by the inflationary impact of the weaker rand. Market consensus forecasts a further rate hike of 25 basis points in November and an aggregate 75 basis point increase in 2016 depending on market reaction to the Federal Reserve’s anticipated rate hikes.

• Foreign investors were net buyers of R6bn worth of bonds and R0.6bn worth of equities last week. Foreigners accounted for only 27.9% of total equity market traded volume which is low compared to the year-to-date average of 38.9%. Foreign equity buying was concentrated in the industrial sector, followed by the financial sector and resource sector, while net selling was noted in the property sector. For the year-to-date foreign net buying of bonds and equities amounts to R18.74bn and R35.89bn respectively.

• The SA Reserve Bank’s (Sarb) leading economic indicator (LEI) fell in May for a 20th straight month to its lowest since November 2009 falling -3.4% year-on-year following its -1.5% decline in April. The LEI is comprised of ten variables with seven showing declines in the latest reading. The biggest negative contributors were the number of building plans passed, the percentage change in job advertisements, business confidence, and vehicle sales. The LEI readings signal a weakening economic outlook further exacerbated by the recent interest rate increase.

Political review

• The government’s draft Promotion and Protection of Investment Bill which will replace bilateral investment treaties has been altered slightly to address concerns that foreign investors would have to rely on SA-based dispute arbitration. The Bill has been altered to accommodate a limited form of foreign arbitration once all domestic arbitration measures have been tried. However, foreign arbitration is not an automatic right but comes instead at the discretion of government, which is unlikely to provide much comfort for foreign investors.

• Draft amendments to the Preferential Procurement Policy Framework Act change the weighting allocated to price competitiveness on the one hand and empowerment on the other for the award of state tenders below R10m. The weighting has been changed from 80/20 (in favour of price competitiveness) to 50/50, which means firms with full broad-based empowerment could quote nearly double the price of a firm with no empowerment and still win the contract. The draft amendments have drawn strong criticism from opposition parties and business leaders on the grounds that they contravene constitutional requirements that efficient, economic and effective use of resources must be promoted.

The week ahead

• Quarterly Labour Force Survey: Due Tuesday 28th July. The survey is expected to show that the unemployment rate increased from 26.4% in the first quarter (Q1) to 26.6% in Q2. Contraction in mining and manufacturing output during Q2 indicates job losses in these two industrial sectors.

• Producer price inflation (PPI): Due Thursday 30th July. PPI is expected to accelerate from 3.6% year-on-year in May to 3.9% in June. PPI is closely monitored as a lead indicator of consumer price inflation.

• Trade balance: Due Friday 31st July. Following the unexpected +R5bn trade surplus in May the balance is expected to return to a deficit of –R1.5bn in June. The May numbers were flattered by a rebound from especially weak exports in April due to the number of public holidays which occurred in that month. Meanwhile declining commodity prices may have affected the value of total exports during June.

• Private Sector Credit Extension (PSCE): Due Friday 31st July. PSCE is expected to remain stable in June with growth unchanged at +9.5% year-on-year. While corporate credit growth is likely to remain firm at around +15% household credit extension is expected to remain extremely weak. Data from the National Credit Regulator confirms that consumer loan impairments and delinquencies increased during the first quarter indicative of rising financial distress among households.

Technical analysis

• The rand remains below successive support levels suggesting a continuation in the rand’s depreciation. A break above the key “Fibonacci” level of R/$12.45 signals further depreciation in the rand to the R/$13.00 level.

• 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.

• Despite the recent uptick in bond yields 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 above key resistance levels of 2% and 2.2%. However, there is unlikely to be a major bear trend in US bonds as the deleveraging phase is still in its early stages.

• The benchmark R186 SA Gilt yield is testing support at 8.15% and needs to break below resistance at 7.90% in order to resume its bull trend.

• The MSCI World Equity index is in the 5th and final wave of a rising-wedge formation. A rising-wedge formation is a typical trend-ending signal. European equities are set to outperform US markets. The Nikkei exhibits the most bullish pattern.  

• 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 can be expected in the next year. The next major wave down will complete the 16-17 year secular bear market that started in 2000. The secular bottom should occur around June 2016.

• The S&P 500 is breaking down from a rising wedge pattern, which is traditionally a trend-changing pattern. A break below the previous low of 2067 will confirm a trend reversal. A further negative signal is that the Dow Jones Transport Index, traditionally a lead indicator for the broader market, has already broken down from its rising wedge.

• Brent crude’s break below the key $60 support level suggests a continuation of the weakening long-term trend. Copper is regarded a reliable lead indicator for industrial commodity prices and barometer of global economic growth. It has broken below the 2011 low of $6 500 suggesting a further downside move to $5 500.  

• Despite recent advances Gold is in a protracted bear market signalled by rapid declines through successive support levels at $1 300, $1 250 and $1 100. Gold’s next target is $1 000 which is likely to be breached before the bear market ends.  

• The All Share index has lost most of its gains since the start of the year. The All Share Index is testing the key support line which has been in place since 2009. A break below 50 000 would signal a sharp move lower to the October low of 47 000.

Bottom line

• As expected the SA Reserve Bank (Sarb) lifted interest rates at its policy meeting last Thursday 23rd July, hiking the repo rate from 5.75% to 6%. The motivation behind the rate hike is to address the weakening rand which is largely responsible for rising inflationary pressure. It is hoped that higher interest rates will lure foreign bond investors. However, the thinking may be flawed: Since the start of the year foreign investors have been far more focussed on equity investment than bond investment with net equity inflows of R35.89bn over the period compared with equivalent inflows of just R18.74bn into local bond markets. The Sarb should be focussing on making the equity market more attractive to foreign investors. However, higher interest rates will further weaken an already anaemic economic growth and profit outlook. The rand hedge stocks will benefit from a weaker rand but foreign investors are only interested in domestically focussed stocks.

• It is unfortunate for the country’s households, which are already struggling under the weight of weak employment growth, high indebtedness, and above inflation increases in state administered prices, that the rate hike has back-fired. Instead of strengthening after the interest rate hike the rand has been the second weakest performer (after Brazil) out of all emerging market currencies falling from R/$12.35 to R/$12.65, a fall of almost 3% in just two trading days. It is likely that the Sarb will continue to raise interest rates hoping to turn the direction of the rand. However, this policy is likely to exacerbate the currency’s weakness by further diminishing foreign investors’ appetite for domestically focussed equities.

• Local investors are well advised to under-weight domestically focussed equities in favour of rand hedge stocks. Rising interest rates amid weakening economic growth will further dent domestic earnings which are already under siege from wage disputes, load shedding and weak commodity prices. Rand hedge stocks should continue to outperform, with the rand expected to depreciate further despite the best intentions of the Sarb.

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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Rand - Dollar
18.94
-0.2%
Rand - Pound
23.91
-0.1%
Rand - Euro
20.45
+0.1%
Rand - Aus dollar
12.35
+0.0%
Rand - Yen
0.13
-0.2%
Platinum
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+0.9%
Palladium
1,012.82
+1.1%
Gold
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Silver
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Brent-ruolie
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Top 40
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All Share
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Resource 10
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