Summary of macro-economic research views:
- Inflation: Inflation is expected to start declining convincingly in the coming months and may well re-enter the 3-6% inflation target range by mid-year. By the end of the year the headline inflation rate is expected to trend back towards the midpoint of 4.5% or below.
- Repo rate: Following the last 25bp rate hike to take the repo rate to 7.25%, there is scope for one more similar 25bp rate hike, although this is far from guaranteed. The interest rate outlook has stabilised and the repo rate will likely peak at the next meeting.
- Fiscal Policy: Eskom’s debt levels are expected to drop as the government rolls some of its debt onto the public balance sheet. It implies that the debt/GDP ratio for the country will rise more rapidly towards the 80% mark depending on how much debt is rolled up and how long severe load-shedding persists. For now, the bond market will continue to price in a healthy discount to foreigners.
- GDP Growth: Thanks to load-shedding, private sector growth forecasts have been revised downwards and are now expected to however around 0.3%-0.6% for the year, depending on the severity of the load-shedding and the mitigation efforts by government.
- Currency: According to ETM’s ZSI, valuations metrics, carry attractiveness and resilience, the balance of forces favours a ZAR recovery back towards 15.00/dlr in the next 9m, with fair-value hovering closer to 15.50/6000 at the moment. The environment favours exporters at present.
- Bonds: Bond yields are well positioned to gain strongly through the year as the interest rate cycle turns, the globe heads into a downturn and inflation reverses strongly as the monetary stimulus that caused it, is withdrawn. Fund managers are exposed more to medium to longer dated bonds, and expect bonds to outperform equities this year.
It is often useful to find a tool that helps unpack value ranges quantitatively, preventing emotional decision-making when hedging. Traditionally, understanding value has been a somewhat nebulous concept that comes down to a range of factors, including what kind of tolerance a business has for unfavourable currency movements. The indicators that follow attempt to identify different periods that might offer relative value, either for importers or for exporters.
- Since the December report and throughout January, the ZAR Sentiment Indicator (ZSI) has continued to surge. The demand for hedging at these weaker ZAR levels remains subdued and that implies that demand for USDs to cover hedged demand in the future will also be lower.
- The implication is that the ZAR could still stage a recovery back towards 15.00/dlr. The biggest risk to this view is ongoing intense load-shedding.
- Through the past six weeks, the USD has retreated off its highs. It surged into very overvalued territory, but has since started to retreat. The catalyst for the move is the growing expectation that the economy will reverse in the near future and that the Fed will lead other central banks in reducing interest rates.
- From these levels, the risks are asymmetrically skewed against the USD and one would favour greater normalisation to the downside than the USD surging again.
- Portfolio flows have turned a little sluggish at the start of the year, especially into bonds. Uncertainty concerning the outlook for US rates has hampered performance, while SA has faced numerous challenges, mostly related to Eskom and load-shedding that have also detracted from their attractiveness.
- News that National Treasury will absorb some of Eskom’s debt on to the public balance sheet will only serve to further detract from the appeal of SA bonds, although when inflation retreats, that attraction should re-establish itself.
- The USD-ZAR in this chart is offering tremendous value as it trades above the 75th percentile of the value range (i.e. above the blue line).
- This is a clear indication that exporters will find tremendous value in locking in attractive forward rates, given that historically, such levels of exporter value have not been sustained for very long.
- Fair value currently rests closer to 16.00/dlr if the ZAR were to stage a recovery now, which is based on an observed risk assessment which would include Eskom.
- The most notable change since the previous report is the rise in the monetary rectitude score that now hovers around 5/10. This is a strong recovery from the mere 2/10 achieved during the pandemic when the SARB chose to slash interest rates to unsustainably low levels.
- However, as the SARB has kept pace with other central banks to protect the value of the ZAR and reduce inflationary pressures, the score has improved to drag South Africa into the top third of a twenty-two country sample.
- The ZAR’s carry attractiveness score has been rising as the SARB continues to hike rates and as implied volatility levels subside into the end of the year. The ZAR still ranks higher than both EM and DM averages and thus the ZAR still holds some attraction for foreigners looking to take advantage of carry returns.
- Key to that support has been the rate hikes that have bolstered money market and bond yields, which is a function of a SARB that remains conservative in its stance and determined to protect the value of the ZAR.
- 2023 has ushered in a change of sentiment towards the USD. Speculators have moved from being stubbornly long USDs for over 18m to suddenly shifting back into bearish territory.
- Although the USD has retreated significantly off its highs, the long-term valuation chart suggests that it could have further to go and lose a further 10% from current levels. That will have implications for most EM currencies vs the USD.
- Terms-of-trade (ToT) have improved through the past month and the gains have consolidated. At these levels, SA’s terms of trade are supportive of the ZAR and would go a long way to improving the currency’s overall resilience.
- The gains in the terms of trade need to be considered against the backdrop of the load-shedding and SA’s logistical bottlenecks that will prevent the country from taking full advantage. However, the ToT are supportive nonetheless.
- ETM’s inflation risk index has dipped firmly back into deflation territory and will facilitate the inflation rate moderating sharply through the months ahead. The index measures the underlying momentum (blue line) to inflation (red line).
- This gives one a clear indication that the pressure on the SARB will ease and that interest rates will likely top out very soon. As inflation continues to moderate through the year ahead, interest rate expectations will shift to favour cuts.
- While trade volumes have increased, growth in exports has lagged that of imports, resulting in a narrowing of the trade account.
- While SA still produces a trade surplus, it is no longer an obvious driver of ZAR resilience and will do little to prevent the current account deficit from becoming more entrenched. That being said, it cannot be considered a detractor from the ZAR either.