Forex Daily Market - Factory price growth in SA has accelerated

In today's market update, factory price growth in South Africa has accelerated every month since reaching lows in May last year, and this is expected to have continued to April.

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TODAY'S TALKING POINT

PPI y/y: Apr

Expected: 6.9%

Prior: 5.2%

 

Analysis: Factory price growth in South Africa has accelerated every month since reaching lows in May last year, and this is expected to have continued to April. Producer price inflation came in at 5.2% y/y in March, the fastest growth pace in more than a year as a result of increasing global commodity prices. Analysts surveyed by Bloomberg are pencilling in for producer price growth to surge even higher in April. Supply-side constraints due to the adverse impact of the COVID-19 pandemics and persistent rising commodity prices are likely to be the key drivers. Base effects will also play a major role here, given how low PPI was through Q2 of 2020. High supply-side inflation, however, may not filter through to the consumer side given SA’s current demand dynamics, suggesting it will place suppliers under even more financial pressure.

RAND UPDATE

The ZAR extended its current winning streak against the USD for the fifth day yesterday. After hovering near 22-month lows through most of the day, the ZAR bulls found enough impetus to break through a July 2019 high around 13.8100/$. While domestic developments this week have offered the local unit a tailwind, the ZAR has made steady progress since early March, where it was trading near the top of its wide 14.5000-15.5000 Q1 range at the time. The local currency’s outperformance amongst other EM currencies has been notable due to the combination of a commodity-lifted domestic trade balance and overwhelming bias against the USD.

 

As for the US dollar, the greenback has remained subdued this week by continued dovish Fed speak, and the market seems to be buying into the central bank’s narrative that the coming inflationary pressure will be transitory. US Treasury yields have meanwhile eased from March highs and, as such, the dollar which received support earlier this year on higher Treasury yields has steadily declined on a trade-weighted basis over the past two months.

 

While the ZAR may continue to gain in the near term, the timeframe for ZAR strength will begin to disappear looking further out. Idiosyncratic factors will likely start to weigh on domestic assets once again after stimulus-driven flows into local markets begin to slow and as domestic imports improve and lessen the trade surplus. Further down the line, the ZAR does remain prone to correction once the stimulus taps in the developed world are closed and if the domestic economic recovery has not kept up the pace for the SARB to hike rates in response.

BOND UPDATE

PPI data will hold some interest today for those concerned about inflation risk. Factory price growth in South Africa has accelerated every month since reaching lows in May last year, and this is expected to have continued in April. Producer price inflation came in at 5.2% y/y in March, the fastest growth rate in more than a year because of increasing global commodity prices. Analysts surveyed by Bloomberg are pencilling in for producer price growth to surge even higher in April.

 

SAGBs are clearly pricing in a lower inflation outlook on the back of the downside pressure on spot USD-ZAR, with the entire curve shifting lower in response. The longest-dated R2048 is notably lower at 10.56%, which marks a near 90bp gain from March peaks at 11.42%. The 20-year breakeven rate (expected inflation risk in the bond market) as calculated by Bloomberg has also compressed. At levels of 6.55%, it has trended lower from March peaks of 7.24%. However, the 5-year breakeven rate has stayed relatively buoyed at a level of 4.6%. The latter suggests that the current outlook for inflation to move back towards the midpoint of the SARB’s target band remains in place, despite the ZAR’s continued rally. This could change if PPI and other major inflation data surprise to the downside in the coming months.

 

The other major event of the day will be the SARB financial stability review, which takes place at 4:30 pm. The SARB will deliver a macroprudential analysis of the SA economy. We expect that the message delivered in this forum is unlikely to shift the existing narrative so soon after an MPC.

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