In a perfect storm: the rand's underperformance
The global and domestic backdrop has been unfavourable for the rand. Year to date, on average, the rand is 18.6% weaker against the US dollar (as of 13 June), 16.6% weaker against the euro, and 11.7% weaker against the British pound. The rand has also reflected the weakest performance against the US dollar compared to other emerging market currencies and commodity currencies such as the Australian dollar and the Canadian dollar. It has, nonetheless, gained over the past few days following its sharp depreciation, spurred by the adverse market reaction to the suspicion of SA's sale of weapons to Russia as well as increasing concerns of a possible national blackout in winter (though this is unlikely). It could receive further support from the US Fed's pause in its interest rate hiking cycle, with the opposite likely if the Fed resumes hiking again.
Nevertheless, at yesterday's close of R18.33 against the US dollar, the rand remains significantly undervalued and vulnerable to event risks. Roughly, it should be trading around R17.55 to R17.60 when accounting for US-SA relative fundamentals such as inflation and growth, and separately accounting for metal prices. Below we unpack some of the global and domestic themes the rand is already discounting.
The global backdrop remains fluid and unfavourable for riskier EM currencies
The World Bank's latest global economic outlook is for global growth to fall from an estimated 3.1% in 2022 to 2.1% this year, before gradually increasing to below pre- pandemic growth of 2.4% and 3.0% in 2024 and 2025 respectively. The World Bank sees risks to the global growth prognosis to be skewed to the downside, related to persistent inflation and tighter-than-anticipated monetary policy. Trade fragmentation, with geopolitical tensions triggering the implementation of inward-looking policies, poses a downside risk to the global economic environment. Generally, this should weigh on riskier emerging market currencies, such as the rand, as global investor risk appetite deteriorates. Additionally, as a commodity currency, the rand confronts moderating commodity prices amid the unfavourable global backdrop, including less support from China's consumption and services-led economic recovery.
Idiosyncratic factors have differentiated the rand from other EM and commodity currencies
While the global backdrop has weighed on the rand and other EM and commodity currencies, the rand has relatively overreacted, reflecting adverse country-specific risk factors. South Africa's 2023 growth prognosis has deteriorated from above 1% at the end of last year and now reflects a stagnation. This broadly underscores the combined decimating impact of the hard power shortages, logistical challenges, elevated inflation, and tighter monetary policy. Confidence across most sectors remains depressed, and businesses are increasingly concerned about the constraining impact of the political climate. Combined, all these factors weigh on the rand as a risky EM currency, and compound its volatility. While it has recently gained, upcoming events such as the August BRICS summit and the 2024 National Elections will be another test for the rand. Additionally, the widening current account deficit and the deteriorating fiscal outlook in a contemporaneously tighter global financing environment should put pressure on the rand. Although our economic projections currently discount elevated levels of load-shedding up to stage 8, additional stages of load-shedding will have a material bearing on the outlook, including the rand. Our current house view is for the rand to gain from the recent weaker levels but remain undervalued, averaging around R18.80 against the US dollar this year before rebounding to R18.00 in 2024. The lingering rand-negative risks and persistent inflation have further twisted the MPC's hand to tighten monetary policy and impaired its ability to provide near-term relief to the worrying economic growth prognosis. However, given the SARB's credibility and somewhat weakening consumer demand and headline inflation pressures, excessive rand depreciation from current levels is arguably limited, but this does not eliminate a possible short-lived weakness, particularly from the upcoming BRICs summit and 2024 elections.
Week in review
Mining output (not seasonally adjusted) expanded by 2.3% y/y in April, reflecting a rebound from an upwardly revised 2.2% y/y contraction (previously 2.6% y/y contraction) in March. The growth rebound in mining output comes after 14 consecutive months of annual decline and marks a better start to the current quarter. The outturn was better than the Bloomberg consensus prediction of a 1.5% y/y expansion. Seasonally adjusted mining output, which aligns with the official calculation of real quarterly GDP, increased by 1.8% m/m, following an upwardly revised 6.9% m/m increase (previously 6.5% m/m increase) in March. Despite intense load-shedding in April, the monthly increase in output reflects resilience in the sector and, if sustained, could imply increasingly less reliance on the Eskom electricity grid. Nevertheless, logistics challenges and slowing external demand remain a near-term constraint on mining output.
Notwithstanding the annual growth rebound in April, mining output is still down by 2.4% y/y year to date (January to April). Still, it reflects significant improvement from the 7.2% y/y contraction recorded over the corresponding period last year. We expect a relatively shallow contraction of 3.2% y/y (previously 2.5% y/y contraction) this year from a 7.3% annual contraction in 2022. The envisaged weakness in mining output underscores the constraining impact of hard power shortages, logistics challenges, and moderating external demand. A recovery is envisaged beyond 2023 as additional generation capacity reduces load-shedding and the external environment becomes favourable.
Retail sales volumes declined by 1.6% y/y in April, from an upwardly revised decline of 1.5% in the previous month (revised from -1.6%). This outcome was marginally worse than Reuters consensus expectation of -1.4% and marks a fifth consecutive month of annual decline in sales volumes. Nevertheless, seasonally adjusted volumes increased by 0.4% month-on-month, following a decline of 0.6% in March (revised marginally up from -0.7%). This, together with monthly mining and manufacturing production data, suggests a reasonable start to 2Q23 GDP, despite intense load-shedding and a few public holidays in April. However, longer-term trends suggest waning consumer resilience, with more hurdles on the horizon, including the cumulative impact of past interest rate decisions. Year to date, volume sales are lower by 1.1% compared to the same period last year.
High-frequency bank credit data suggests that consumers are still accumulating consumption credit at a relatively faster pace, though the trend has plateaued in the last few months. The slowing pace in the last few months likely reflects a tightening in lending standards, as high living and debt servicing costs continue to erode consumers' affordability. We expect that lending standards will tighten further, as the cumulative impact of past interest rate decisions filters through, and in turn weigh on shopping activity. From an income perspective, we expect that the sharp increase in production and operational costs induced by load-shedding will eventually weigh on corporate margins and consequently, employment and wage gains. This, combined with elevated inflation and rising debt servicing costs, as well as depressed consumer confidence, suggests a muted household consumption expenditure growth prognosis.
The FNB/BER Building Confidence Index shed five points to register a level of 28 in 2Q23. By sub-sector, building material manufacturers were lone gainers, adding 7 index points, albeit from extremely low levels. Both quantity surveyors and architects shed 3 index points, while hardware retailers and building sub-contractors shed 13 and 17 points respectively. The confidence of main contractors was unchanged, at a relatively robust but still depressed 43 index points. Nevertheless, activity among main contractors declined in 2Q23, reversing some of the gains made in the past few quarters. This is primarily due to higher interest rates and a slowing semigration trend that is starting to weigh on building activity in the Western Cape, which has performed relatively well in the past few quarters. Hardware retailers also saw a significant decline in activity, alongside subdued consumer demand. Of additional concern is the broad- based expectation that activity and hardware retail volume sales will likely come under further pressure over the short term. In contrast, activity at the start of the building pipeline improved (architects and quantity surveyors), although it remains to be seen whether this translates into better activity down the value chain. Overall, while we are still convinced that the building sector bottomed sometime in the middle of last year, the momentum eased in 2Q23.
Week ahead
On Tuesday, the leading business cycle indicator for April will be published. The leading business cycle indicator measured 117.8 points in March, reflecting a monthly decline of 2.0%, following a downwardly revised 0.5% fall in February. On an annual basis, the leading indicator plummeted by 7.8%, the largest year-on-year decline since August 2009. This was the fourth consecutive month of monthly declines in business indicators (and twelfth annual decline), with five out of the seven available components declining. The largest negative contributions were from the decline in South Africa's US-dollar denominated export commodity price index and a deceleration in the six-month smoothed growth rate in real M1 money supply. On the other hand, positive contributions were from an increase in the number of residential building plans approved and an acceleration in the composite leading business cycle indicator for South Africa's major trading-partner countries.
On Wednesday, data on consumer inflation for May will be published. Headline inflation slowed to 6.8% y/y in April, down from 7.1% in March, and had monthly pressure of 0.4%. Core inflation was 5.3% y/y and 0.5% m/m, driven by price pressures in medical insurance, vehicles, and alcoholic beverages and tobacco. Fuel fell by 0.7% m/m and was 5.0% y/y, down from 8.1% previously. Food and non-alcoholic beverages (NAB) inflation still reflected monthly pressure of 0.6% and remained sticky at 13.9% y/y. We predict headline inflation of 6.4% y/y and 0.3% m/m in May, reflecting positive base effects. Food inflation will be an important driver given the strong acceleration experienced from May 2022. However, we remain concerned about the impact of intensified load-shedding this winter, which should lift the marginal cost of supply and reduce the benefit of expected base effects. Furthermore, the recent weakening of the rand should have added to imported inflation, affecting various items across the consumer basket. We expect average headline inflation of 6.2% this year.
Tables
The key data in review
| Date | Country | Release/Event | Period | Act | Prior |
|---|---|---|---|---|---|
| 13 Jun | SA | Mining Production m/m | Apr | 1.8 | 6.9 |
| SA | Mining Production y/y | Apr | 2.3 | -2.2 | |
| 14 Jun | SA | Retail Sales m/m | Apr | 0,4 | -0,6 |
| SA | Retail Sales y/y | Apr | -1,6 | -1,5 | |
| 15 Jun | SA | FNB/BER building confidence index | Q2 | 28 | 33 |
Data to watch out for this week
| Date | Country | Release/Event | Period | Survey | Prior |
|---|---|---|---|---|---|
| 20 Jun | SA | Leading Business Cycle Indicator | Apr | 117,8 | |
| 21 Jun | SA | Headline CPI m/m | May | 0.4 | |
| SA | Headline CPI y/y | May | 0.4 |
Financial market indicators
| Indicator | Level | 1W | 1M | 1Y |
|---|---|---|---|---|
| All Share | 78 060.22 | 1.2% | -0.3% | 18.8% |
| USD/ZAR | 18.35 | -3.9% | -5.1% | 14.4% |
| EUR/ZAR | 19.87 | -2.7% | -5.3% | 18.8% |
| GBP/ZAR | 23.23 | -2.2% | -3.5% | 20.7% |
| Platinum US$/oz | 981,14 | -4,0% | -6,8% | 6,1% |
| Gold US$/oz | 1 942.52 | 0.1% | -3.4% | 7.4% |
| Brent US$/oz | 73.20 | -4.9% | -1.3% | -39.6% |
| SA 10 year bond yield | 10.69 | -2.0% | -1.8% | 3.2% |
FNB SA Economic Forecast
| Economic Indicator | 2020 | 2021 | 2022 | 2023f | 2024f |
|---|---|---|---|---|---|
| Real GDP %y/y | -6.0 | 4.7 | 1.9 | -0.1 | 1.1 |
| Household consumption expenditure % y/y | -6.1 | 5.8 | 2.5 | 0.8 | 0.9 |
| Gross fixed capital formation % y/y | -14.6 | 0.6 | 4.8 | 4.2 | 3.0 |
| CPI (average) %y/y | 3.3 | 4.5 | 6.9 | 6.2 | 5.5 |
| CPI (year end) % y/y | 3.1 | 5.9 | 7.2 | 5.8 | 4.9 |
| Repo rate (year end) %p.a.* | 3.50 | 3.75 | 7.00 | 8.50 | 8.25 |
| Prime (year end) %p.a.* | 7.00 | 7.25 | 10.50 | 12.00 | 11.75 |
| USDZAR (average) | 16.60 | 14.80 | 16.40 | 18.80 | 18.00 |
Source: FNB
