The primary economic talking point for the financial markets this week is whether global inflationary pressures will prove transitory or persistent and how central banks will respond. This has been a recurring theme over the past few months, one that we have touched on several times in our weekly news flashes.
The impact for currencies appears mixed. Commodity currencies, including the rand, enjoyed a lift on strong materials prices, then retreated yesterday. Many traders seem to be betting that the Bank of England will soon raise interest rates to curb inflation. The US dollar, meanwhile, weakened against major peers as traders bet other central banks would raise interest rates before the Fed.
We can expect major currencies to remain volatile as long as it remains unclear whether monetary policy will be tightened, or inflation will fall as supply constraints ease. Many investors are flagging concerns about how inflationary increases may stall economic growth and corporate earnings following their recovery from the downturn caused by the global pandemic.
However, the Fed has changed the way it views inflation, and has adopted an Average Inflation Targeting approach, which links monetary policy to average rates of inflation over a prior period, rather than on real-time data.
The first school of thought is that, should inflation be entrenched at higher levels, the central banks would be “behind the curve”, requiring a more aggressive rate tightening. This would tend to result in dollar strength and consequent weakness in emerging market currencies,
The second school of thought is if inflation and supply bottlenecks were to be transitory, inflation would move substantially lower. Under such circumstances, central banks could maintain their highly accommodative monetary policy, which would tend to weaken the dollar and strengthen emerging market currencies.
With reference to the rand, we believe that SA-specific risks are not being adequately factored into the current exchange rate. We therefore expect to witness a weaker bias to the currency over the next year.
“It is certainly evident that there is a lot more inflation on the horizon.”
– Ian Lyngen, analyst at BMO Capital Markets
Global News
- According to UBS, the strong start to Q3 earnings is a reminder that many of the largest sectors in the index are not significantly exposed to recent concerns over supply chains, including financials, internet, software, and healthcare. “Overall, we expect a drag on earnings per share from supply chain problems of just 1% for 2021 – a modest hit relative to our projection for 45% profit growth for the year.”
- In this environment, smaller companies are starting to attract investor attention. We currently access these lesser researched – relative to large cap shares – via a UK listed investment trust, where importantly, the underlying global holdings have an emphasis on quality.
- On Tuesday, strength in Asia pulled through to US markets, and the S&P 500 notched up its fifth straight gain. Positive moves from Tencent and Alibaba lifted sentiment globally. Tencent was up another 2.3% on Wednesday, which is great news for Naspers and Prosus shareholders.
- By Thursday, US equities had continued their rally, putting the benchmark S&P 500 within a whisker of its closing high. The S&P 500 gained 0.4% as traders weighed company earnings against risks from inflationary pressures. The gains come on the heels of the S&P 500’s best start to an earnings season in the last two years with the index gaining about 4.6% from the middle of last week.
- In company news, Alibaba shares surged more than 6% on Wednesday following reports that billionaire founder Jack Ma was in Europe. This has fuelled investor hopes that the worst of China’s regulatory crackdown for the internet giant might be over. The Chinese authorities have cracked down on a host of tech and other industries deemed to have become too powerful, unregulated or monopolistic.
- However, Evergrande, China’s most indebted property developer with some $300 billion in debt, remains in crisis mode. It has now entered discussions with a rival Hong Kong based property company called Hopson Development Holdings to try and sell them 50.1% of a portion of their business. Unfortunately, those talks failed during the week. It has already missed three dollar-bond interest payments worth $277 million since 23 September 2021, but now appears to have sourced funds to make the coupon payments. Despite this development, October payments have since been missed and the risk of default remains high.
- Apple had a very successful product announcement event, with initial reviews on the new, more powerful MacBook Pros being positive. Apple also unveiled new AirPods, updates to the HomePro Mini smart-speaker line-up, and tweaks to the Apple Music offering, which will be more integrated with voice-assistant Siri. Apple will also be making its own chips, which will improve profit margins.
- Tesla has reported third-quarter revenue that fell short of Wall Street estimates but managed to beat profit projections, overcoming a semiconductor shortage and supply chain challenges that have hindered competing automakers. Elon Musk is now worth a quarter of a trillion dollars and is right on top of the world’s richest list.
- The Verge reports that Facebook plans to announce a name change in the coming week. The new name is intended to highlight Facebook’s drive to create the metaverse in a move similar to Google’s parent company changing its name to Alphabet.
- A collection of documents shows what Daily Maverick calls the “shocking extent” to which Investec was involved in suspect deals worth hundreds of millions of euros that resulted in European governments being defrauded through the infamous “cum-ex” withholding tax scam. Investec has now joined the ranks of lawyers, bankers and financial services outfits from across the world already implicated in what is widely reported to be the largest tax fraud in history, allegedly costing European revenue services more than €55 billion, mostly between 2007 and 2012.
Local News
- Although our local currency appears range-bound, it is likely to move sharply once the direction of global inflation is better understood, which in our view represents a significant risk for investors. Currently, the rand is trading below fair value which is estimated by us to be R15.02 to the dollar. At today’s market prices of around R14.65 to the dollar, there is a fairly a compelling case for externalisation: History has shown that the rand trades lower than fair value only 12% of the time, and indicators suggest the local currency is running out of steam.
- Another risk for the rand is concern that an Evergrande default remains high. Any contagion effect could unsettle financial markets including emerging market currencies such as the rand. While the rand could rally somewhat in the very short-term given that Evergrande has managed to avoid an immediate default, the risk of rand weakness through this uncertain phase of a possible Evergrande default remains significant.
- Meanwhile, consumer inflation in September moved up to its highest level since May and recorded its fifth month out of line with the 4.5% midpoint of the South African Reserve Bank’s target range. September’s increase to 5% year-on-year, which was driven by hikes in fuel, food, housing and utilities, was in line with expectations. But it comes as rising energy prices and supply chain bottlenecks stoke global inflation fears and developed market central banks make more noise about tightening monetary policy sooner rather than later.
- SA interest rate hikes are a close call for the November MPC meeting. While all are of the opinion that rates need to normalise, the view of pace and ultimate normal level of those rates is certainly not unanimous. Nevertheless, the bond market is currently pricing in a repo rate hike of 25bps at the November meeting, with further hikes expected next year.
- SA corporates are beginning to harvest “sustainability” opportunities: Woolworths now wants to make sure all its clothing and homeware products have a recycled or previously used element after 2030, to reduce the waste produced when making consumer products. In June, Woolworths became the first South African retailer to raise a R1.1 billion sustainability-linked loan from Standard Bank. Hospital group Netcare was the first listed local company to announce a sustainability loan in March when it raised just over R1 billion in a three-year bond from Standard Bank with interest rates and debt linked to its plans to reduce carbon emissions, water and electricity use.
- This comes as Pick ‘n Pay revealed the July unrest cost it R930 million in lost sales, the first food retailer to report on the effect the July unrest had on performance. The group said it lost a further R800 million as a result of government’s restrictions on the trade of alcohol, bringing the overall revenue loss as a result of trading disruptions for the year to about R1.7 billion. However, insurance will cover most of the group’s losses, with about R600 million already paid out.
- The South African film and entertainment industry can generate R120 billion for the economy, a large increase from the R20 billion it currently generates. However, for this to successfully transpire, critical changes are required. This includes direct flights between Cape Town and New York, increased capacity to build film and sound sets, and a simple, reliable, and efficient government rebate regime.
Sources: Dynasty, Vestact, Analytics Consulting, BusinessLive, Bloomberg, Moneyweb, Daily Maverick etc.
