Daily Commentary - 07 February 2018

Contact Merchant West Capital Markets on: (+2711) 305-9500 or treasury@merchantwest.co.za

- USD / ZAR 11.8965 - EUR / ZAR 14.7424 - GBP / ZAR 16.6312 -

Economic Events:

07 Feb : No data of real importance

08 Feb : SA Manufacturing Prod NSA ( y/y)  - SA State of the Nation Address

09 Feb : No data of real importance

Market Commentary:

On the Local Front:

South Africa's rand firmed against the dollar on Tuesday as the market positioned for the possible removal from office of President Jacob Zuma, while share prices hit a four-month low as the global stocks rout intensified. At 17h23, the rand traded at 12.0300 per dollar, 0.78 percent firmer than its close on Monday. This morning we opened around the 11.91 level, now trading at 11.9600. "Speculation about an imminent removal of President Zuma has intensified. His removal must surely now mostly be in the price but we would still expect a knee-jerk reaction when it transpires," Rand Merchant Bank analyst John Cairns said in a note.

The speaker of parliament said on Tuesday the president's state of the nation address, which had been scheduled for Thursday, would be postponed, hinting at the growing pressure on Zuma to step down. His scandal-plagued tenure has been seen as a weight on the economy, and the rand has tightened up to its firmest in over two years as the likelihood of his removal grew after Cyril Ramaphosa was elected party chief in December. Government bonds also firmed, with the yield on the benchmark instrument due in 2026 ZAR 186 down 3.5 basis points to 8.47 percent.

On the bourse, the Johannesburg All-Share index weakened 1.29 percent to 56,377 points, while the Top-40 index declined 1.27 percent to 49,855 points, both to levels last seen in October 2017. The equity market selloff had been viewed by some as a healthy correction after a rapid run up over the last year, but as it snowballed through Asia and Europe and looked to be on its way back to Wall Street, nerves were starting to fray. "While the fall in global equity markets looks dramatic, it is no more dramatic than the record rises we have seen since the end of November. For that reason alone many would argue a correction was on the cards," said Jacob Deppe, head of trading at online trading platform Infinox in a note. "The party may be over for now but this could be more of a sobering correction than a rout."

We expect the ZAR to surrender some of its recent gains: ( Absa’s SA Research published on 05 February 2018)

Based on our valuations the ZAR is overbought: Although ZAR bulls cheered the outcome of December’s ANC elective conference, we believe it will take time for improved business and consumer confidence to translate into higher levels of GDP growth. GDP differentials is one of the variables in our structural USDZAR model and based on our view that GDP growth will pick up to only 1.4% this year, this model suggests that the ZAR is currently fairly valued at 14.70/USD. Our tactical model, which captures the risk-on global environment, suggests the ZAR should be no stronger than 12.78/USD.

The bearish USD trade looks crowded: In recent months, the ZAR has benefited from USD weakness, but given an expected widening in US interest rate differentials and the fact that EURUSD speculators are already extremely long EUR, we believe that the USD could enjoy a respite over the coming months.

Moody’s downgrade could result in considerable outflows from the bond market: Given our house view that Moody’s is more likely than not to downgrade SA’s local-currency rating to sub-IG at the end of February/early March, we believe the ZAR is vulnerable to between USD8-12bn of portfolio outflows over the coming weeks. This is because a Moody’s downgrade would eject SAGBs from the World Government Bond Index (WGBI) and, in turn, obligate foreign bond investors that passively track the index to sell their SAGB holdings. These investors would have four to six weeks to sell and it would only be a ZAR-neutral event if these foreign investors sell their SAGBs to other foreign investors.

On the domestic data front:

South Africa's business confidence rose for a third month in a row in January to its highest since late 2015, on expectations that the new leadership of the ruling party will stabilise economic policy, a survey showed on Tuesday. The South African Chamber of Commerce and Industry's (SACCI) monthly business confidence index rose to 99.7 in January from 96.4 in December. Increases in import volumes, a stronger currency and higher retail sales volumes all boosted sentiment, the business body said. "There is the expectation that new leadership will lead to more promising and consistent business and economic policy options," economists at SACCI said in a statement. The continent's most industrialised economy sank into recession in the first quarter of 2017 before recovering, but investor and consumer confidence have remained subdued due to political and policy uncertainty linked to President Jacob Zuma.

Our range on the day: 11.80 – 12.10