Inside Insights 21 Feb 2011

Investment Intelligence|Inside Insights

A weekly, in-depth yet concise report on the most important recent market movements and economic developments.

Added on 21 February 2011 @ 10:32 AM

Where to next for the rand?

The rand turned 50 last Monday, but there has been little celebration for the local currency since the start of the year. The rand-dollar exchange rate was R6.61/$ at the end of December; at the end of last week it was at R7.13/$. This happened despite the fact that the dollar itself is weaker against other major currencies. Demand for emerging market assets has slipped recently, while rising interest rates in certain countries (e.g. Australia) may be attracting more attention from a carry trade point of view.

For the first two decades of its existence, one rand could buy more than one dollar. From the early 1980s, however, South Africa's local political situation and international isolation price caused the rand to weaken rapidly. This trend continued after 1994, with the currency breaking through double-digit levels against the dollar by the turn of the millennium. At that point, many thought the currency would weaken even further and took money offshore, buying an overvalued dollar and overvalued offshore assets. The global commodities boom helped the rand regain lost ground, though, until the global financial crisis caused another blow-out in 2008. Once again, the rand staged a fairly rapid recovery, beginning in early 2009. If there is a lesson from all this, it is that the currency's long-term trajectory has been to weaken against the dollar (which is in line with inflation differentials between the two countries), while over the past decade, this has coincided with considerable volatility. Hedging a portfolio against this volatility would have been very beneficial.

Speaking of history, last week also saw the JSE All Share index touch its previous all-time high of 33232 points, before dropping back. Corporates worldwide have been reporting solid results, supporting equities. Meanwhile, the weaker rand has clearly benefited local resource shares, as have higher world commodity prices. However, this combination of factors does not bode well for the local inflation outlook. Incidentally, the rand was trading at R7.61/$ when the JSE peaked in March 2008.

Inflation and spending on the up

If there was still hope for an interest rate cut, last week's data releases surely killed it. Consumer inflation continued its upward march, while December retail sales beat expectations. The rand traded at its weakest level since August last week (though it came back strongly on Friday), while unrest in the Middle East kept Brent crude oil prices firmly above $100/barrel.

Consumer inflation increased to 3.7% year-on-year in January, up from 3.5% in December, and in line with market expectations. Food inflation in January was 2.9% year-on-year, not particularly high, but double December's rate, while petrol prices were 11.5% higher than a year ago, thanks to the 29c/l increase. The education, health, alcohol and tobacco and housing (electricity) sub-components of CPI all increased faster than the 6% upper limit of the Reserve Bank's target. Recreation and communication components showed negative growth. The upward drift in consumer inflation is expected to continue during the course of the year.

Real retail sales grew unexpectedly strongly by 8.3% year-on-year in December, up from a revised growth rate of 8% in November (previously 7.8%). The consensus expectation was for 7.7% growth. All major categories of the retail sector showed growth on a year-on-year, with the largest category, general retailers, growing robustly by 9% year-on-year. For 2010 as a whole, retail sales were 5.2% higher, after contracting by 3.6% in 2009, with consumer confidence boosted by lower interest rates, lower inflation and healthy wage increases. However, with the economy having lost around a million jobs during the recession, and with household debt levels still high, retail sales growth rates are not expected to shoot the lights out. The base effect will also fade out in the months to come, while petrol prices might eat a growing share of consumption spending. Finally, the impact of yet more electricity tariff increases and the introduction of tolls on Gauteng freeways remains to be seen.

The Week Ahead

• StatsSA releases fourth quarter gross domestic product (GDP) growth numbers on Tuesday. Economists polled by I-Net expect quarter-on-quarter growth of between 3.7% and 4.5% in Q4, up from Q3's disappointing 2.6% growth rate. The mining and retail sectors in particular rebounded strongly over the quarter.

• The Reserve Bank releases its leading economic indicator for December on Tuesday. The leading indicator is a gauge for economic growth 6 - 12 months ahead.

• Finance minister Pravin Gordhan will deliver the Budget Speech in Parliament on Wednesday. Analysts will be looking for more detail around the plans for job creation and economic growth announced by President Zuma in his State of the Nation address. Slight upward adjustments to income tax brackets are also expected, while smokers and drinkers will want to know by how much sin taxes will be hiked. The budget deficit for the fiscal year is expected to be slightly less than the 5.3% of GDP that was projected in the October mini-budget. While large, the deficit compares very favourably with those of advanced economies.

• On Thursday, StatsSA is expected to release slightly lower producer inflation (PPI) numbers for January, after December's 5.8% year-on-year reading.

• International data releases of note this week: German Ifo confidence survey for February; US December Case-Shiller house price index, January new and existing home sales and durable goods orders, February consumer confidence, Q4 GDP; UK Q4 GDP; Japan January foreign trade balance.

Fairbairn Capital | Old Mutual

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