Summary of macro-economic research views:
- Inflation: Inflation continues to trend lower. The May inflation picture will print around 6.5% or below, and in the two following months, inflation could drop back below the upper limit of the 3-6% inflation target range. That will ease pressure on the SARB and re-establish SA’s positive real yields.
- Repo rate: The SARB opted to lift rates by 50bp at the last meeting to take the repo rate up to 8.25%. As things stand, investors are anticipating that the SARB will hike another two more times of 25bp each. Much of that will depend on the ZAR consolidating its real gains or appreciating further.
- 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 assumptions of much higher growth.
- 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 0.4% in 2023. The degree of contraction will depend on the extent of the load shedding and the degree of volatility in the ZAR. At the moment, both have improved, but that is not guaranteed to last.
- Currency: As tumultuous and difficult as May was, June has been the opposite and more than unwound the depreciation recorded in May. While portfolio outflows have hindered the performance of the ZAR, those portfolio flows appear to have reversed in the ZAR’s favour as foreign investors see value in SA’s high yields and the ZAR’s undervaluation.
- Bonds: Bonds had an awful May and lost tremendous ground. However, the appreciation of the ZAR through June has played an enormous role in bolstering the appeal of SA bonds, that have unwound at least half the losses sustained through May. With inflation set to decline, the real yield bonds will offer are set to increase substantially.
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.
- It is often interesting to conduct a mean reversion study on the ZAR to see where it could recover to if previous such episodes are considered. Typically, the following trajectory follows once the ZAR has depreciated by 26% or more.
- The latest ZAR recovery may have begun this journey, but according to previous such episodes, it may still have a lot further to run. It could well surprise investors and offer importers some value to tap into.
- Applying that same methodology to the USD-ZAR and the value bands shows that this is an opportune time for exporters to take advantage of attractive forward rates. Whenever the USD-ZAR has exceeded the 90th percentile value range, such moves have not been sustained very long.
- Typically, this study shows that a year from now, the forward rates typically exceed the prevailing spot rate by quite some margin to bolster the coffers of those companies that export.
- Portfolio flows have been a significant driver of currency direction. Specifically, the bond market fits best with the USD-ZAR, suggesting that either the flows into bonds are driving direction of the ZAR or vice versa.
- If one therefore holds a fundamentally sound belief that bonds offer value, then one could build a strong argument for why the ZAR might appreciate from current levels. Although bonds do have to factor in a lot of bad news that reflects fiscal risk, they are still offering tremendous real-yield returns.
- Oil prices are well off their highs of two months ago and have remained depressed despite OPEC trimming production on a few occasions. Against this dip in oil prices, the rest of the commodity basket has held up reasonably well, helping to improve SA’s terms of trade.
- While SA’s terms of trade remain supportive of the ZAR by bolstering the trade account, the ZAR will hold the potential to extend the recovery that began a couple of weeks ago.
- Data released recently showed that the current account narrowed far more than expected. The trade balance has turned more positive when including gold, while the income and transfers account has turned less negative on the back of foreigners holding fewer SA assets.
- Although portfolio flows have been negative and added to the drain, the situation might’ve been a lot worse had the current account not narrowed.
- On average, the ZAR’s carry attractiveness score remains above that of other emerging markets and comfortably ahead of the average DM carry attractiveness score. It suggests that the ZAR retains enough attraction that when investors start to focus on yield once more, exposure to SA will be considered.
- With inflation now falling to help preserve real yields, with domestic demand weakening thanks to higher rates, and with the terms of trade still favorable, SA’s carry attractiveness could still improve a little further.
- Momentum behind inflation is still expected to subside through the months ahead with ETM’s inflation risk indicator still pointing to some disinflation. Expectations are for inflation to ease through the months ahead.
- The implication for ZAR is that the inflation differential may become less of a driver of currency bias in the months ahead, especially if inflation can drop to within the SARB’s 3-6% inflation target band.
- Although the overall resilience score has not improved considerably, the boost that the monetary rectitude will offer through the months ahead, will likely bolster the ZAR’s resilience.
- However, the biggest detractor, as it has been for many years now, is the fiscal rectitude score that is struggling to improve from the very poor 2.5/10. Equally, fundamentals are unlikely to improve any time soon thanks to higher interest rates, buoyant inflation and the persistent load shedding.
- 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 turns from hawkish, to neutral and then loose, investors will 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.
- USD liquidity continues to be withdrawn from the system, and all indications are that the red line will continue to migrate lower to the point where the environment becomes ripe for another crisis.
- This could spell bad news for the ZAR that remains more sensitive the tighter the global liquidity conditions become. At distressed times (the troughs in this chart) EM currency volatility tends to be more pronounced.