Domestic financial conditions could tighten amid rand weakness
This week we look at broader financial conditions against policy interest rates that have increased considerably relative to their pandemic lows. In the US, the Federal Reserve increased the policy rate by a cumulative 500bps since the start of its hiking cycle in March 2022. Meanwhile, the South African Reserve Bank's (SARB) Monetary Policy Committee (MPC) tightened rates by a cumulative 425bps since November 2021. Although the policy rate is at its highest in 14 years, significant upside risk prevails. In particular, the rand continues to weaken amid weaker domestic fundamentals that should be worsened by power cuts at higher stages during the winter season. More adverse risk sentiment towards South African assets and the impact of higher imported inflation lifts the probability of further tightening even as domestic growth remains materially challenged.
The rand movement
Yesterday the rand breached R19.30/$, the weakest level since the height of the pandemic lockdown in April 2020 when a high of R19.20/$ was recorded. YTD, the rand was weaker by 17.6% as of yesterday, 11 May 2023. On a real trade-weighted basis, it was weaker by 8.6% at the end of 1Q23. Furthermore, it has weakened by over 7% since the previous MPC meeting in March. Unlike during the height of the pandemic in 2020, when global financial turmoil affected the rand along with other emerging market currencies, current rand weakness primarily reflects weakening domestic fundamentals. In particular, load-shedding induced downward revisions to economic growth, unfavourable current account forecasts and increased risk aversion towards South African assets. As highlighted here, further rand weakness will affect domestic inflation through imported products, while also threatening the global competitiveness of domestic firms (production costs and exports). Ultimately, there are implications for economic growth and employment.
Implications for domestic financial conditions
To better understand domestic financial conditions, we look at the Financial Conditions Index (FCI), which tracks an array of financial variables, not just interest rates alone. Unsurprisingly, the FCI shows tighter conditions alongside the tightening interest rate cycle (see Figures 1 & 3). The FCI1 measured -0.91 in March, tighter than -0.70 in February and -0.84 in December 2022. It was also tighter than it was at the end of 2021, when the MPC began the hiking cycle to normalise interest rates and curb runaway inflation. Despite this, the FCI remains higher than recorded during the pandemic (-3.63 in April 2020) and during the 2008/09 global financial crisis (-4.29 in November 2008). This implies that even though conditions are tightening, they are not overly restrictive.
Underscoring tightening financial conditions is the inflation-adjusted JSE All Share Index, which was down by 4.6% y/y in March, extending the decline to eleven successive months. The real trade-weighted rand exchange rate has also persistently weakened, declining by 12.6% y/y in March following an 8.9% y/y decline in February. The inflation-adjusted house price index declined by 5.0% y/y in March, reflecting further weakness from -4.7% y/y in February. The credit default spread (five-year CDS) increased by 21bps in March and 62bps since October 2021, weighing on financial conditions. In contrast, quantity variables such as household and corporate credit growth have supported financial conditions. However, this may be transitory amid heightened uncertainty and the higherfor- longer prime lending rate.
Overall, while domestic financial conditions have deteriorated since the start of the hiking cycle in November 2021 and point to weaker economic activity, they are not excessively restrictive. However, conditions could further weaken as risk aversion against domestic assets increases and exchange rate volatility persists.
Week in review
SA's gross foreign exchange reserves slid to $61.72 billion in April, from $61.85 billion in March. The decline primarily reflects government-related foreign exchange payments and would have been more pronounced had it not been for an increase in the dollar-denominated gold price and asset price changes.
Mining output (not seasonally adjusted) contracted by 2.6% y/y in March, reflecting an improvement from a materially downwardly revised 7.6% y/y contraction (previously -5.0%) in February. Nevertheless, the annual decline in mining output has been persistent for fourteen straight months, mirroring the material impact of idiosyncratic structural bottlenecks. Surprisingly, seasonally adjusted mining output increased by a robust 6.5% m/m in March, following a material decline of 7.0% m/m (downwardly revised from 4.9%) in February. While mining output for March is encouraging, we are concerned about the wide retrospective revisions causing economic forecast volatility. That being said, output grew by 1.0% q/q in 1Q23, following a 3.4% quarterly decline in 4Q22, and likely contributed to 1Q23 real GDP growth. This is despite intensified load-shedding between 1Q23 and 4Q22 and counteracts the negative contributions from new vehicle sales and electricity generation. We maintain our view of a decline in aggregate mining output this year at around 2.5%, shallower than the sector's Gross Value Added decline of 7.0% in 2022. While the prices of most of SA's major export commodities have moderated amid slowing global growth, idiosyncratic factors such as intensified load-shedding, transport and logistics challenges, as well as elevated input costs are expected to weigh heavily on production and export volumes. Over the medium term, we expect industries implementing measures like electricity selfgeneration to mitigate the impact of load-shedding, which should support a recovery in output.
Total manufacturing output (not seasonally adjusted) contracted by a shallow 1.1% y/y in March, following a downwardly revised 5.6% y/y contraction (previously 5.2% y/y contraction) in February. Encouragingly, seasonally adjusted manufacturing output rebounded strongly, posting 4.0% m/m in March after declining by 1.3% m/m in February. The PMI business activity index measured 48.1 points in March from 45.5 points in February, indicating that monthly output was expected to improve but remain in contraction due to hard power shortages. In contrast, the stronger-than-expected monthly increase in output reflects the dynamic impact of load-shedding on the economy and adds to forecast volatility. Manufacturing output grew by 1.4% q/q in 1Q23, following a quarterly contraction of 1.5% in 4Q22. This data, alongside mining production, suggests that the economic growth outcome may have been marginally better than previously envisaged. We will await the rest of the high-frequency data (trade and tourism-related data, as well as transportation) over the next two weeks before finalising our 1Q23 real GDP estimate. We maintain our view that the outlook for the manufacturing sector remains precarious as hard power shortages and transport logistic challenges persist. Weakening domestic and external demand should also weigh on manufacturing activity this year.
Week ahead
The Quarterly Labour Force Statistics (QLFS) for 1Q23 will be released on Tuesday. The QLFS data (not seasonally adjusted) showed that the official unemployment rate remained high at 32.7% in 4Q22 but reflected a slight moderation from 32.9% in 3Q22. The unemployment rate averaged 33.5% in 2022, lower than the 34.3% average for 2021 but higher than the 28.7% average for 2019. Overall, the economy continued creating jobs in 4Q22, with cumulative net job gains over the past five quarters amounting to 1 652 486, comprising 1 348 973 formal jobs and 303 513 other jobs. There were 169 089 (1.1% q/q) net job gains in 4Q22, while net job gains were 1 390 362 (9.6%) compared to the same quarter last year. The unemployment level rose by 28 252 q/q (but declined by 168 049 y/y) to 7 753 383. Part of the robust annual growth in the labour force is due to the lower base created by the lingering impact of the July 2021 civil unrest.
On Wednesday, data on retail sales for March will be published. Retail sales volumes for February declined by 0.5% y/y, marking a third consecutive month of annual decline. The seasonally adjusted volumes slid by 0.1% m/m, following a 1.5% m/m increase in January and a 0.5% decline in December. As such, three months-on-three months volume sales are still higher by 1.2%, suggesting a slight positive contribution from the retail trade sector to 1Q23 GDP so far. Nevertheless, a sluggish labour market, high living costs and depressed consumer confidence suggest muted shopping activity in the coming months
Tables
The key data in review
| Date | Country | Release/Event | Period | Act | Prior |
|---|---|---|---|---|---|
| 28 Apr | SA | Gross reserves (US$ billion) | Mar | 61.72 | 61.85 |
| 2 May | SA | Mining production y/y | Apr | -2.6% | -7.6% |
| SA | Mining production m/m | Mar | 6.5% | -7.0% | |
| 4 May | SA | Manufacturing production y/y | Mar | -1.1% | -5.6% |
| SA | Manufacturing production m/m | Mar | 4.0% | -1.3% |
Data to watch out for this week
| Date | Country | Release/Event | Period | Act | Prior |
|---|---|---|---|---|---|
| 16 May | SA | Unemployment rate | 1Q23 | -- | 32.7% |
| 17 May | SA | Retail sales y/y | Mar | -0.9% | -0.5% |
| SA | Retail sales m/m | Mar | -- | -0.1% |
Financial market indicators
| Indicator | Level | 1W | 1M | 1Y |
|---|---|---|---|---|
| All Share | 76,997.16 | -0.4% | -1.3% | 12.5% |
| USD/ZAR | 19.21 | 5.0% | 4.4% | 19.4% |
| EUR/ZAR | 20.99 | 4.3% | 4.5% | 23.9% |
| GBP/ZAR | 24.01 | 4.4% | 5.1% | 21.8% |
| Platinum US$/oz | 1,096.93 | 4.7% | 9.9% | 10.2% |
| Gold US$/oz | 2,015.05 | -1.7% | 0.6% | 8.8% |
| Brent US$/oz | 74.98 | 3.4% | -12.4% | -30.3% |
| SA 10 year bond yield | 10.88 | 7.9% | 9.8% | 8.3% |
FNB SA Economic Forecast
| Economic Indicator | 2020 | 2021 | 2022 | 2023f | 2024f |
|---|---|---|---|---|---|
| Real GDP %y/y | -6.3 | 4.9 | 2.0 | 0.4 | 1.4 |
| Household consumption expenditure % y/y | -5.9 | 5.6 | 2.6 | 0.8 | 1.4 |
| Gross fixed capital formation % y/y | -14.6 | 0.2 | 4.7 | 3.6 | 3.2 |
| CPI (average) %y/y | 3.3 | 5.9 | 7.2 | 5.9 | 5.4 |
| CPI (year end) % y/y | 3.1 | 5.9 | 7.2 | 5.0 | 5.4 |
| Repo rate (year end) %p.a.* | 3.50 | 3.75 | 7.00 | 7.75 | 7.50 |
| Prime (year end) %p.a.* | 7.00 | 7.25 | 10.50 | 11.25 | 11.00 |
| USDZAR (average) | 16.60 | 14.80 | 16.40 | 17.70 | 17.70 |
Source: FNB
