Summary of macro-economic research views:
- Inflation: Inflation has stalled, and the latest bout of ZAR weakness will elevate the inflationary pressures going forward. Although inflation is expected to subside below 7% and towards the upper limit of the 3-6% inflation target range in the months ahead, the trajectory will be a little shallower.
- Repo rate: The past week’s events have dealt SA financial markets a massive blow. Expectations for repo have changed and are now pricing in much higher interest rates compared to a month ago. As the FRA rates stand, the market anticipates at least a 50bp hike at the next meeting, with a further 50-75bp worth of hikes thereafter.
- Fiscal Policy: With much of Eskom’s debt rolling onto the sovereign’s balance sheet, the debt/GDP ratio for the country is forecast to rise towards the 75% mark. Risks have escalated, given the weak GDP growth outlook and the disappointing tax revenues generated recently. This adds to the risk consideration of investing in SA.
- GDP Growth: GDP growth forecasts will need to be revised downwards, and given the events of the past week, GDP could contract by as much as 1.0% in 2023. The degree of contraction will depend on the extent of the ZAR’s sell-off and the impact this ultimately has on inflation.
- Currency: At present, sentiment and emotion are driving the ZAR, which has responded to a perfect storm of bad news. While blowing out, the ZAR remains super sensitive to news flow, and given the circumstances, that might still result in a USD-ZAR spiking further before recovering. Fair value a year from now remains closer to 17.00/dlr.
- Bonds: Bonds have suffered a terrible May so far, but yields have risen to levels of obvious value, especially for “inflation-plus” investment mandates. While it is difficult to buy into an asset whose price is falling, bonds will likely generate very strong returns over the next two years.
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.
- How much further could the ZAR collapse? It now becomes anybody’s guess. Judging by previous cycles, it could extend a little further, but that amounts to pure speculation, there is no science behind that expectation, just examples of previous blow-outs and how they have played out.
- Within the broader band of explosive blow-outs, a move potentially as high as 21.00/dlr might be possible, but so much will depend on how the authorities including the SARB respond to the current volatility.
- Such has been the collapse of the ZAR that on the observed risk, statistical valuation metric, the ZAR has now entered extreme undervaluation levels, not dissimilar to those seen in at the start of Covid and during Nenegate. If there was ever any doubt about just how stressed this environment has become, now there should be none. The ZAR is in freefall and while that may be unsustainable, it will probably require some aggressive response from the SARB in order to jolt investors out of selling the ZAR aggressively.
- Portfolio flows have been an issue. The drain, especially out of bonds has been a big factor and one of the most influential drivers of the ZAR. As fund managers have steadily taken more funds abroad to take advantage of the raised prudential limit of 45%, against a backdrop of load shedding, greylisting and now frictions with the US over the country’s relations with China, the ZAR has come under considerable pressure. Outflows from both bonds and equities so far this yer have been significant.
- Oil prices are well off their highs of a month ago, while the gold price is slightly higher. The combination has helped SA’s terms of trade improve and they remain more supportive of ZAR resilience through supporting the trade account.
- Real economy trade flows are therefore somewhat supportive of the ZAR and over time will assist the local curreny make a recovery. The minute the speculative short-term portfolio flows stabilise the real economy flows will reassert their influence.
- Although SA’s trade balance has narrowed steadily as a trend, the trade account remains in surplus. Looking ahead, this will not be enough to put the current account in surplus, but will still support the ZAR at the margin.
- As the terms of trade improve and the ZAR’s recent blow-out renders imports a lot more expensive, the trade balance will again be well supported and counterbalance the portfolio outflows that have turned into a trend more recently.
- As domestic interest rates have steadily climbed, so SA’s carry attractiveness has been protected. With domestic interest rates set to rise even further, SA’s score will continue rising.
- Perhaps the biggest concern is that SA’s score is being skewed higher by the subdued volatility contribution to the higher score that will surely reverse given the most recent price moves.
- Momentum behind inflation is still expected to subside through the months ahead with ETM’s inflation risk indicator still pointing to some disinflation. Momentum has dissipated and expectations are for inflation to ease through the months ahead.
- The implicaton for ZAR is that the inflation differential may become less of a driver of currency bias.
- Analysis of the resilience indicators is instructive. The heavy lifting is currently being done by the SARB and there may be a lot more to do. A deeper collapse by the ZAR may well force the SARB to respond in the only way it can and that would be raise overall rates.
- That would push the overall resilience score higher and inject some support into the ZAR to stabilize it, returning the monetary score back to levels sustained Nenegate in 2015 and the onset of the Covid pandemic.
- 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 eventually support a recovery in ZAR vs the USD. However, investors with exposure to ZAR will need to be patient until ZAR risk aversion subsides.
- As if the domestic factors weren’t enough, the dollar liquidity cycle shows that the tide is now going out. It means that global financial markets will experience a slightly more stressed environment that could foster a stronger bout of risk aversion.
- This could spell bad news for the ZAR that remains more sensitive the tighter the global liquidity conditions become. At distressed times (the trough in this chart) EM currency volatility tends to be more pronounced.