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 4.5% target midpoint.
- Repo rate: Following the last 50bp rate hike to take the repo rate to 7.75%, there is scope for one more 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. Much depends on what other major central banks do in the next few weeks, however.
- Fiscal Policy: With much of Eskom’s debt rolling on the sovereign’s balance sheet, the debt/GDP ratio for the country is forecast to rise towards the 75% mark. Risks are tilted to the topside, however, with economic growth deteriorating and pressure to increase spending on public wages and social transfers remaining. The positive is that fiscal authorities maintain a strong resolve to right the course to a more sustainable trajectory. Still, the bond market will continue to price in a healthy discount to foreigners.
- GDP Growth: Due to persistent load-shedding, private sector growth forecasts have been revised downwards and could even turn mildly negative for the year, depending on the severity of the load-shedding and the mitigation efforts by government. Risks are tilted to the downside, however, with a recession on the cards in H1.
- Currency: According to ETM’s ZSI, valuations metrics, carry attractiveness and resilience, the balance of forces favours a ZAR recovery back towards 16.0000/$in the next nine months, with fair-value hovering closer to 16.50 at the moment. That is to say that the environment favours exporters at present.
- Bonds: Bond are well positioned to gain strongly through the year as the interest rate cycle turns, the globe heads into a downturn and inflation reverses as the monetary stimulus that caused it, is withdrawn.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 tools that help 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.
- Although there are question marks concerning some of the sub-components utilised to construct the ZSI, which might explain the recent deviation, the indicator still holds some predictive value and predicts that the ZAR could stage a material recovery later this year.
- Currently, it is the low volatility environment that may be distorting the outcome of this indicator. Adjustments are being considered, although it is unlikely that the conclusion of ZAR appreciation changes substantially.
- Notwithstanding the latest bout of ZAR appreciation, it continues to trade deep in undervalued territory and close to levels of extreme undervaluation. The chart illustrates that there is obvious value for exporters to take advantage of, and that fair value lies closer to 16.50/dlr a year from now.
- Typically, such degrees of undervaluation have not lasted particularly long and suggest that a phase of ZAR recovery will follow.
- Portfolio flows play a significant role in driving currencies. In SA’s case, movements in the underlying bond market in particular have a significant influence on the performance of the ZAR.
- As bonds have had a difficult time of late, the ZAR has suffered too. There has been market talk of local fund managers maximising their offshore allowances and of foreigners reducing their holdings of SA assets due to the rising risks associated with load shedding, SOEs and the greylisting.
- Since the last report, terms-of-trade have improved slightly and could improve a lot further as the USD slides. Much will depend on whether the oil price remains buoyant or starts to price in a softening in global demand beyond what other commodity prices are doing.
- Imports of oil remain one of the biggest drivers of SA’s terms of trade and while the recent rise in crude oil prices was unwelcome, the fact that the gold price has risen has helped offset that to some degree.
- After showing signs of narrowing and even turning into a deficit, the trade surplus has once again widened back out. It would be quite typical of SA to generate trade surpluses when the economy is going through a downgraded GDP growth environment and possible recession.
- Readers are reminded that the ZAR tends to perform better in a weak GDP growth environment when imports crater. With load shedding doing a lot of damage, it is possible the data is starting to reflect this now.
- Following the latest rise in domestic interest rates, the improvement in SA’s terms-of-trade, the moderation in inflation and the improved trade account, it follows that SA’s carry attractiveness index has improved vs both EMs and DMs.
- Although there is not a one-for-one correlation between carry attractiveness and the performance of the ZAR, the data does suggest that SA is in a good position to attract foreign capital should sentiment towards SA improve and the overwhelmingly negative sentiment abates.
- Although more marginal, it is important to note that ETM’s inflation risk indicator is back in disinflation territory. That confirms that despite load shedding and the recent weakness in the ZAR, that inflationary pressures are still expected to moderate, albeit only slowly.
- A return to price stability as reflected in inflation tends to support the underlying currency, another aspect that should help the ZAR at the margin.
- It is telling that the monetary rectitude score is on the rise. Due to the SARB hiking persistently and aggressively, the monetary rectitude score is rising back up and will play a significant role in bolstering support for the ZAR. The ZAR might’ve been significantly weaker had it not been for the SARB.
- It is also encouraging to see the fiscal score rising slightly as tax collections beat expectations and some fiscal consolidation was achieved.
- The USD may be showing signs of capitulating, but it has a long way to go before it is even remotely out of extreme overvaluation. Such periods have not been sustained historically and this time is unlikely to be any different.
- As US monetary policy unwinds and investors review their expectations of the USD, that will support a recovery in ZAR vs the USD. With other countries looking to make less use of the USD to trade in, that too, could exert pressure at the margin.
- Finally, there are clear signs that the US labour market is softening to alleviate some of the anticipated pressure in US wage inflation. That will be a precursor to the Fed easing up on monetary tightening. The data has a long way to go to normalise, but the inflection point has passed.
- Looking forward, the looser JOLTS data will eventually reflect in softer payrolls numbers, higher jobless claims and a jump in unemployment to undermine the USD.