What’s behind the strengthening of the Rand?

Published Date: 18 minFin24Source: Fin24 The rand has gained +15.1% versus the dollar since the start of the year, noted Overberg Asset Management (OAM) in its weekly overview notice of the economic and political landscape in South Africa. The unit has appreciated for seven straight weeks and is the strongest performer among emerging market currencies over the past month with a gain of +7.81%. OAM said that the biggest factor behind the rand’s appreciation is the worldwide search for yield prompted by the negative yields being offered by many developed world government bonds. Over $12trn worth of government bonds worldwide are now trading at negative yields, it added. South Africa economic review: • The rand maintained its winning streak, gaining against the US dollar, euro and pound for a seventh straight week. Over the week the rand appreciated from R/$13.78 to 13.44, from R/€15.25 to 15.02, and from R/£17.99 to 17.38. The rand is at its highest level against the dollar since last September last year. SA government bonds continued to firm with the yield on the 10-year R186 falling from 8.58% to 8.44%. The improving rand is partly attributed to market optimism following the outcome of the local elections. Fitch credit rating agency cautioned that the ANC’s loss in support could tempt the government into shoring-up political support by pursuing more populist policies, which may turn away foreign investors. • Manufacturing production increased in June by a better than expected 4.5% year-on-year building on an already upbeat 3.9% in May and beating the 3.1% consensus forecast. On a month-on-month basis manufacturing output grew by 0.7% boosted by the petrochemical and steel manufacturing sectors, which increased production by 3.1% and 1.1%. For the second quarter (Q2) as a whole, manufacturing production increased by 8.2% quarter-on-quarter annualised, providing a solid boost to Q2 GDP. • Mining production continued its recent recovery with year-on-year contraction moderating from -3.9% in May to -2.5% in June comfortably beating the -3.5% consensus forecast. On a month-on-month basis mining production grew 1.9% building on its upwardly revised 2.7% growth in May. While platinum group metals production fell -12.4% on the month giving back some of its massive 18.8% increase the previous month, the production of iron ore increased by 23.1% on the month and coal by 3.8%. For the second quarter (Q2) as a whole, mining production grew an impressive 17.4% quarter-on-quarter annualised, which combined with solid manufacturing data should ensure a healthy rebound in Q2 GDP growth. • The SA Chamber of Commerce and Industry (Sacci) business confidence index increased slightly from 95.1 in June to 96.0 in July, attributed to a firmer rand and improvements in retail sales and export performance. SACCI cautioned that economic growth prospects remained uncertain noting that the IMF and SA Reserve Bank had lowered their GDP forecasts for 2017. Sacci warned that a concerted effort would be needed to avert even tighter economic conditions in 2017. • Despite a slight improvement in the business confidence index Sacci’s Industry Trade Activity index fell from 51 in June to 47 in July below the key 50-level which demarcates expansion from contraction. According to Sacci: “Respondents cited the decline in economic activity, the predicament of notably small- and medium-sized businesses, the influence of trade unions, and a non-committal approach by government to pro-business policies. The strain led to muted return on assets, and sharp declines in profit margins as consequences of the tight trade environment.” Among the sub-indices the forward-looking new orders index fell from 49 to 44 and the trade expectations index fell from 54 to 52. The week ahead: • Retail sales: Due Wednesday 17th August. Following the buoyant June manufacturing and mining data released last week the retail sales figures will provide the last remaining clue to second quarter GDP. According to consensus forecast retail sales growth is set too moderate slightly from 4.5% year-on-year in May to 4.0% in June. Consumer confidence hit a 15-year low in the second quarter held back by negligible growth in household disposable income amid slow wage growth and rising living costs. Households are also reluctant to borrow due to rising interest rates and high levels of indebtedness. Technical analysis: • The rand has strengthened below key resistance at R/$13.50 and is now comfortably below the 50-, 100- and 200-day moving averages. The rand’s momentum indicators are not confirming the rand’s new lows versus the dollar and therefore a sustained break below R/$13.20 is unlikely. The rand must break above R/$13.60 to indicate that the bottom has been reached. • 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. • Following the Brexit vote the British pound hit its weakest level against the US dollar since 1985. The £/$1.30 level provides key support, which if broken would open up a Fibonacci projected target of £/$1.20-1.24. • 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 below key resistance levels of 1.6% confirming that the major bull trend in US bonds is likely to continue as the deleveraging phase is still in its early stages. • The benchmark R186 SA Gilt yield has compressed to its lowest level since “Nenegate” last year falling below key resistance at 9.0%. The yield is now testing the bottom of the current consolidation channel at 8.5%, which if broken will target a yield of 8.0%. • The MSCI World Equity index has broken downward from a rising trend-line which has been intact since the 2008/09 global financial crisis. Given the magnitude and duration of the 2009-2015 bull market the overall correction is likely to reach a downside target for the MSCI World Equity index of 1,400. • 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 is likely to have just occurred. The next major wave down will complete the 16-17 year secular bear market that started in 2000. The secular bottom should occur between mid-2016 and mid-2017. • The S&P 500 index has broken to new record highs but the rally is not being confirmed by momentum indicators, which suggests the market is overbought and in danger of correction. A further negative signal is that the Dow Jones Transport Index, traditionally a lead indicator for the broader market, is underperforming the broader index. • Despite this year’s price rally Brent crude’s break below the key $30 support level in February suggests a continuation of the weakening long-term trend to a downside $25 target. Copper is regarded a reliable lead indicator for industrial commodity prices and barometer of global economic growth. Despite its recent rally the copper price broke below the key $4 500 support level in February suggesting further downside ahead. • Gold has developed an inverse “head and shoulders” pattern, which indicates further upward momentum and a test of the $1 400 target level. • The JSE All Share index is testing an important resistance line but if this remains unbroken the index is likely to move back below the 24-month moving average at 50 900 in turn opening a downside target of 45 000. A break above 54 200 on the JSE All Share index would project an upward move to 60,000 marking a new high for the JSE. The bottom line: • Emerging market (EM) currencies have continued to strengthen versus the dollar. The rand has appreciated for seven straight weeks. The rand has gained +15.1% versus the dollar since the start of the year and is the strongest performer amongst EM currencies over the past month with a gain of +7.81%. What is the rand’s sharp appreciation attributed to? The biggest factor behind the rand’s appreciation is the worldwide search for yield prompted by the negative yields being offered by many developed world government bonds. Over $12 trillion worth of government bonds worldwide are now trading at negative yields. • The recovery in commodity prices since the start of the year has helped demand for commodity producing currencies such as the Brazilian real and SA rand. China’s monetary and fiscal stimulus have restored the country’s demand for commodities. The rand has also benefitted from country-specific developments. The local elections have boosted confidence in the rand due both to the successful democratic election process and the increase in support for the DA at the expense of the ANC. The SA economy has shown early signs of recovery. June’s improved manufacturing and mining production data are consistent with quarter-on-quarter annualised growth in GDP of around 1.5% in the second quarter. However, this growth rate is unlikely to be sustained during the second half of the year with expectations of close to zero GDP growth for 2016 as a whole. • There are risks that the current benevolent backdrop for the rand may fade over coming weeks or months. The worldwide search for yield has been fuelled by expectations of further monetary easing by the Bank of England, European Central Bank and Bank of Japan. However, the market underestimates the speed and extent of Federal Reserve tightening over the next 18 months. • Fed chair Janet Yellen is likely to give clearer signals of Fed tightening at the upcoming Jackson Hole central bankers’ symposium on 26th August. Fed tightening may lead to an abrupt reversal of EM inflows. Inflation is already above the Fed’s 2% target level and will undoubtedly accelerate as wage pressure increases. US wages are growing at an annual rate of 2.6% and likely to spike higher as the labour market tightens further. • The strong rebound in commodity prices is dependent on China’s continued economic recovery. China’s credit growth, fixed asset investment and industrial production are starting to flag following the initial pick-up in the first half of the year, signalling a potential topping-out in commodity prices. A decline in China’s economic growth rate and demand for commodities would dampen demand for EM assets. • SA’s local election results increase the complexity of the political landscape. Three of the eight large metros will be governed by coalitions, which could be unstable. As highlighted by Fitch credit rating agency, the ANC may be inclined to shore-up its dwindling support by adopting more populist policies. • EM inflows are notoriously cyclical. Net foreign inflows into EM bonds and equities have hit multi-year highs. However, from these elevated levels it may not be long before foreign demand begins to ebb especially if the Fed starts to hike interest rates and China’s demand for commodities begins to fade. 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

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