Sasfin : Forex Daily Market - Trade surplus narrows

Today's Talking Point

Trade Balance: Apr

Expected: -R0.5bn

Prior: R6.9bn

Analysis: Last month's trade balance narrowed sharply to R6.9bn from R10.7bn in February. The narrowing of the trade surplus in recent months leaves the currency vulnerable to external factors. Somewhat paradoxically, a weaker rand may support a positive trade balance in the longer term. While consumer goods become more expensive, commodity exports are priced higher. The risk factor is fuel. Oil prices in rand terms were higher in April but have fortunately flattened out since then. On top of the weak currency, weak domestic economic growth will likely hamper the demand for imports further, to the benefit of the trade surplus. Despite these broader factors, the trade surplus will likely have contracted somewhat in April.

Rand Update

The latest government finance statistics published yesterday showed SA's budget deficit widened from R46.1bn to R67.5bn in April. While this was consistent with seasonal trends, it still reflected notable resilience in corporate tax revenues despite economic weakness in SA. Companies might be coping better than expected with permanent load-shedding, and foreign earnings are likely being declared in a much weaker rand environment. However, on the expenditure front, austerity is still needed in the face of ever-growing spending demands. Government's budget position looks set to worsen as economic reality bites. Recall that the February budget was based on an economic growth forecast of 0.9% in 2023, which will prove extremely optimistic. The SARB forecasts economic growth of just 0.3% for 2023, and the house view is for the economy to contract 0.4%.

Today, the South African data card will be headlined by trade balance statistics for April. Last month's trade balance narrowed sharply to R6.9bn from R10.7bn in February. The narrowing of the trade surplus in recent months leaves the currency vulnerable to external factors. Somewhat paradoxically, a weaker rand may support a positive trade balance in the longer term. While consumer goods become more expensive, commodity exports are priced higher. The risk factor is fuel. Oil prices in rand terms were higher in April but have fortunately flattened out since then. On top of the weak currency, weak domestic economic growth will likely hamper the demand for imports further, to the benefit of the trade surplus. Despite these broader factors, the trade surplus will likely have contracted somewhat in April.

Looking beyond April, it is noteworthy that SA's terms of trade have deteriorated in May. The outlook for commodity markets is weakening as China's economic rebound falters. To that point, May PMI data published out of China overnight reflected growing strain in the manufacturing sector and slowing momentum in the services sector, with the manufacturing PMI falling to 48.8 and the non-manufacturing PMI to 54.5. The world's number-two economy is evidently losing steam, and without policy support in the months ahead, will likely continue to through H2 of this year. This suggests commodity markets may remain under the gun, which would weaken SA's trade balance and, in turn, weigh on the ZAR's resilience to external shocks.

Despite pulling back from a fresh all-time low against the USD during intraday trade yesterday, the ZAR has continued to weaken and underperform its emerging-market peers. It has performed no better against the EUR and GBP, and looks poised for further losses in the immediate short term. Demand dynamics at yesterday's government bond auction suggested that investor sentiment towards SA has not yet recovered, while cautious trading conditions ahead of the US House of Representatives' debt ceiling vote later today will likely also not help its cause. Accordingly, further consolidation with a bearish tilt is expected today, with fresh directional cues to follow from the House vote this evening.

Bond Update

Bonds/Yield Curve: Although government finance stats largely met expectations, risks of fiscal underperformance are building. SA's economic cycle is facing some extremely strong headwinds and a recession is now looking a certainty through the quarters ahead as SA GDP growth for 2023 could well turn negative. While on one hand that could be good news for bonds, on the other, the amount of risk being priced into SA's bond market is not.

Nonetheless, demand at yesterday's bond auction was solid, with acceptable cover ratios, but demand remains down on the auctions seen before the ZAR's slide. Clearing yields are still well above the averages over the past five auctions, and that indicates a market that has positioned for a difficult fiscal environment, elevated inflation and a SARB that is forced to persist with more restrictive monetary policy for longer. Today, some focus will turn to the trade balance for insight into how much of the portfolio outflows from bonds can be offset by the trade surplus, but quite clearly, it hasn't been high enough in recent weeks.

This leaves bond yields elevated and the market positioning for more tightening from the SARB. The overall curve shape is likely to flatten further through the months ahead, especially if the ZAR experiences another surge of depreciation.

FRAs: Notwithstanding all that investors have priced in, the FRA curve continues to attract some paying interest, especially in the middle to longer portion of the curve. Investors remain concerned that the ZAR is far from done with its phase of depreciation and could experience another massive bout of selling, which would translate into further significant inflationary pressure to force the SARB's hand. The market remains convinced of another 50bp hike at the next meeting, with a further 25bp hike factored in after that. Much will depend on the data, the performance of the ZAR and whether inflation continues to surprise to the downside. Currently, the ZAR is on the defensive, and the risk of more rate hikes is high.

Repo: The SARB matched expectations at the previous meeting and moved by another bold 50bp. It did not prevent a further rout on the ZAR, which will see investors anticipate another 50bp hike at the next meeting. With the SARB indicating that the risk of over-tightening is lower than that of under-tightening, the central bank appears to be tilted more in favour of another bold hike fairly late in the cycle. While the ZAR is trading as weak as it is, another 50bp at the next meeting looks plausible. Whether a further 25bp hike after that is justified in line with market expectations is debatable. It will all depend on just how much value foreigners perceive in SA bonds and rates. Once the Fed starts cutting and spreads between SA and US yields widen back out.

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