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Sasfin : Forex Daily Market - the outlook for the US economy remains upbeat -

Today's Talking Point

US Leading Indicators: Nov

Expected: 0.8%

Prior: 0.9%

Analysis: While the outlook for the US economy remains upbeat, downside risks have intensified following the emergence of the Omicron variant. We have seen a number of forecasters downwardly revise their 2022 GDP forecasts citing risks and uncertainty surrounding the new Covid variant, persistent supply chain issues and a faster pace of policy tightening. That said, we caution investors from becoming overly concerned about the Omicron variant if the latest studies are anything to go by. The pace of growth is expected to remain healthy in 2022 but is seen moderating from current levels. This notion is expected to be reflected in the incoming US leading indicator report.

Rand Update

Notwithstanding the risk events of the past week, the ZAR looks set to end the week on the front foot. On Monday, that was considered unlikely given how the Fed would signal a stronger push for normalisation and that the BoE could hike. In the end, that is precisely what happened. Still, instead of emerging market currencies responding negatively to the news that developed market economies would remove the excess liquidity that has supported them, they chose instead to focus on the rally in stock markets which helped boost risk appetite. Whether that will be sustained or not remains to be seen.

Heading into the end of year festive season where liquidity is severely constrained as SA closes down for summer holidays, there are still many risks that abound that are difficult to ignore. The court judgement declaring Zuma's medical parole as unlawful and that he should return to jail may be a win for the country overall concerning the rule of law, but threats of violence have resurfaced. Memories of the violence that erupted earlier this year stoke fears of a repeat, and the country's security cluster are now on high alert.

Secondly, although SA's tourism sector has been spared a shift to higher levels of Covid restrictions over December, the very rapid spread of the Omicron variant still has people concerned that we have not yet witnessed the full effects. Foreign countries that test a lot more than SA are reporting enormous waves of new infections and bracing for a sharp rise in hospitalisations. Although SA data has thus far shown the variant to be milder, it remains too soon to be conclusive, and one cannot rule out the possibility of more Covid-induced volatility in the coming weeks.

Finally, Eskom has indicated that for maintenance purposes, it will shut Koeberg's Unit 2 for maintenance for up to 10 months of 2022. The pained maintenance will remove 928MW of electricity generating capacity, raising the risk of load-shedding. After that, Unit 1 will then be shut for similar reasons and a similar amount removed from the grid. Load shedding has historically been bad for the ZAR. It severely constrains growth, especially in the productive sectors that generate the bulk of SA's exports, including the mines, smelters, and vehicle manufacturing plants.

Bond Update

The week ahead is empty on the local data front, while seasonal dynamics suggest that there will not be much in the way of significant ZAR or SAGB volumes traded until after Christmas. Note that there will be no bond auctions until the 11th of January, further reducing SAGB supply over the next two weeks.

Despite the seasonal wind-down being in full effect, the ZAR could be subject to some volatility in the context of a USD that has rallied overnight as US investors grapple with the implications of the Fed's plans for monetary normalisation. Whether this challenges the recent strengthening trend in SA government bonds is an open question.

While FRA rates compress due to a fragile domestic growth outlook, there is some reason to think that SAGBs could remain subject to bull steepening pressure. Yet in the context of a Fed that is talking up a tightening of monetary policy and slowing Chinese growth, a rally in the bond market might be fleeting. Bullish factors include Fitch's recent comments regarding stabilising fiscal dynamics, while still low hospitalisation rates in SA suggest that fears will recede concerning Omicron's potential threat.

Carry trading may also be at play here, with SA's money market rates relatively high compared to other major currencies. SA's carry attractiveness score is well above the EM and DM average, suggesting that there are reasons to hold the ZAR from a fundamental yield attractiveness perspective. Deteriorating market fundamentals in Turkey are for now being treated as a case-specific incident, although it does help emphasise the relative stability SA for its yield environment. It will be interesting to see whether the ZAR manages to strengthen through Christmas against this backdrop, as was the case in 2019. This time, however, investors will focus on the US monetary policy outlook, with data releases of PCE core on Thursday holding some market-moving potential.

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Sasfin Holdings Limited published this content on 20 December 2021 and is solely responsible for the information contained therein. Distributed by Public, unedited and unaltered, on 20 December 2021 06:49:03 UTC.