Herewith the latest edition of the Monthly Insights. We trust that this will contribute to a broad overview of the interest rate, currency and financial markets. Please feel free to address any questions or comment on the contents to the undersigned.
The latest set of GDP figures paints a sombre picture of the local economy. We now expect the economy to contract by 0.1 % in 2016 (down from our previous forecast of 0.2 % growth), before recovering at a slightly faster pace of 1 % in 2017 (previously 0.9 %). The global backdrop has been similarly tumultuous. The outcome of the UK referendum shocked global markets and has prompted the key rating agencies to downgrade their UK sovereign rating.
The large miscalculation in markets around the Brexit and ensuing market volatility has led to a significant softening of expectations around a US Fed rate hike, and altered the outlook for interest rates globally. The European Central Bank indicated that it was ready to provide further liquidity and BoE Governor Mark Carney suggested that UK interest rates could be cut further.
The recent rally in the rand and supportive global risk appetite, coupled with the fading prospect for US rate hikes, has necessitated a review of our expected inflation profile. Inflation is still forecast to gradually drift higher into the end of the year, although we have revised our previous peak of 7.5 % down substantially to a peak of about 6.8 % by year-end. We therefore expect the MPC to leave interest rates unchanged in July.
We cannot ignore the wave of money flowing into emerging markets. The global search for yield and ensuing yield compression on a global scale is currently unprecedented. Peripheral European bond yields remain well supported despite the heightened sense of political risk. We would not expect to see US yields below European yields unless the US entered a severe recession. South Africa has not been unique in our ability to attract capital flows, which have favoured emerging markets as a whole.
Momentum on the bonds is now remarkably overbought in the near term, and we would be loath to chase lower yields from current levels without a period of short term consolidation. Market expectations around the domestic hiking cycle are now exceptionally flat and are only pricing in a greater than 50 % probability of another 25bps hike from the SARB by the November meeting.
The rand is close to overbought at current levels, but based on our estimates of purchasing power parity the rand is currently around 14.5 % undervalued on a fundamental basis. The powerful developments over the last few weeks necessitate a significantly less bearish estimation of the rand by year-end. We have revised our year-end view significantly lower to the R15.30-R15.50/$ level, compared to our previous estimates of just above R16.00/$.
The pound is now at its weakest level against the US dollar since 1985 and has been the outlying underperformer amongst global majors. The rand has been among the top 3 outperformers after the Brazilian real and Colombian peso. The deferral of a Fed hike for the foreseeable future has however bought EM FX some time, and negates our previously aggressive long dollar positioning for the short to medium term.
Gold has been a large beneficiary of the global risk-off trade, and a test of around $1,400/oz. is still on the cards. Brent crude oil has remained buoyed. We look to a range of $35-$45/bbl. as our longer term estimation of oil prices.
The large scale structural shifts which appear to be underway globally , could necessitate a significant paradigm shift.
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