- The rand’s weakness to R12.73/USD, R15.27/EUR and R17.47/GBP in Q2.18, from a low of R11.51/USD, R14.18/EUR and R16.08/GBP in Q1.18, occurred as global markets factored in higher global inflation (and so interest rate) expectations, in a temporary shift towards the down case. This rand remains volatile, with risk for further weakness.
- Key in the recent global interest rate recalibrations was the US treasury’s (10 year) move above 3.0% (bunds reached 60bp) on inflation fears sparked by rising commodity prices, and seen as a seismic shift as markets looked for higher future US interest rates, which reduced risk appetite.
- Foreigners turned net sellers of emerging market assets to the value of –US$0.2bn in April, with net sales of –US$0.5bn from EM equity markets (IIF). Foreigners sold -R0.2bn worth of SA debt net of purchases for the month of April, but sold –R0.8bn on a net basis in the last week of the month as global markets recalibrated.
- The down and extreme down cases of Investec’s scenarios retain relevance, both due to the risks of international and domestic shocks. International shocks in the down (and extreme down) cases include the risk of an escalation in the US-led trade war with China and/or in geo-political conflict, as well as the risk of a faster than anticipated trajectory in US interest rate hikes, or even a global financial crisis.
- We have (twice) reweighted the probabilities of South Africa’s scenarios since Q4.17 to reflect a marked tilt away from the previous heavy weighting to the downside in 2017. These Q1.18 and Q2.18 reweightings were driven by the decreased likelihood of additional credit rating downgrades and fiscal deterioration in SA. However, despite the reduction in downside risk, the overall weightings for SA’s outlook is still towards the downside (if just markedly less so).
- Looking forward, rising commodity prices will likely place some upwards pressure on US inflation from 2019, and so negatively impact investor sentiment and so EM currencies (such as the rand). Consequently, the risk for additional rand weakness this year in further anticipation of these events is clear. US bond yields will likely rise above 3.0% (begin approaching 4.0%) from as early as the second half of this year into 2019.
- In South Africa consumer confidence rose substantially in Q1.18 (data released in Q2.18), surging to its highest level since the inception of the index, led by improved perceptions of the outlook for the SA economy over the next 12 months. This will likely lead consumer spend, and so GDP growth somewhat stronger, if this level of sentiment is sustained. Confidence levels for high and middle income earners attained record highs, and the number of individuals deeming it appropriate to purchase durable goods presently improved notably.
- Falling consumer inflation, interest rate cuts and a steep recovery in consumer confidence in SA have given support to retail sales, and this is likely to continue in Q2.18, although limited to some extent by the VAT and other consumer tax increases that have come in in this quarter. However, the biggest drag on willingness (as opposed to ability) to spend in the retail sector was the very high levels of uncertainty on the future of the macro economy, with this drag on confidence now eradicated by Cyril Ramaphosa replacing Zuma as President in Q1.18.
- Business confidence is rising domestically, which is expected to aid faster economic growth in SA, with both greater foreign direct, and domestic fixed, investment. Consumers increasingly migrated out of the lower income brackets from 1994 to 2010, and we expect this trend will eventually resume under Cyril Ramaphosa’s Presidency from mid-2019 as wealth and income levels improve, with a lag, as economic growth and the economic outlook does.
- Indeed, faster growth in HCE (household consumption expenditure) could occur than forecast for SA if the Ramaphosa team manages to repair SA’s key institutions quicker than currently expected. This would heavily boost investor sentiment, and so likely investment itself into SA, lifting economic growth towards 5.0% y/y by 2025 instead of the current expectations of 3.5% currently for 2025.
- The domestic economic growth outlook is increasingly positive, as South Africa is expected to rebuild capacity and so lift fixed investment levels, with potential growth lifting. However tailwinds from a global economic slowdown remain the risk in 2019 and particularly 2020.
- The rand has recovered to R12.55/USD, R14.92/EUR and R16.95/GBP with expectations for a possible further move towards R12.00/USD. The down case forecast for Q2.18 is R13.50/USD, with a 21% probability, while the expected case has R11.70/USD with 50% probability. (Q2.18 extreme down case R14.50/USD 14% probability, up case R11.15/USD at 14%, extreme up case R10.75/USD at 1%).
- Interest rate differentials between emerging markets and developed countries still remain attractive, and so EM currencies could see further strength this year, including the rand, as the carry trade resumes after the interruption of recent US dollar strength, while market concerns over the US twin deficits are also likely to resurface.
- Additionally, the global economic recovery has not yet run out of steam, with incoming good macro-economic data readings this year likely to see the US dollar retreat again. It should also be noted that US monetary policy is not expected to be tightened this year or the next couple of years, but rather return to neutral levels instead on interest rate hikes.
- Nevertheless, the greenback could see some further strength again this year from its recent pull back as markets continue to fret over the US interest rate trajectory, and US bond yields. However, the rand benefits from stronger commodity prices, with the commodity rally also unlikely to be over yet. Rand volatility is likely to remain a feature for SA.