S&P and Fitch to release rating upgrades for SA sovereign today

FX

Please note that this is the last edition of The SA Daily for 2014.

Rating agencies S&P and Fitch will release formal ratings updates on the South African sovereign today. Both agencies will publish their updates after South African markets have closed. The risk of any changes being announced sits mostly with respect to Fitch, since the agency has the sovereign rating on a negative outlook, after adjusting it from stable six months ago. Fitch rates South Africa at BBB+ on a local currency (LC) basis and BBB on a foreign currency (FC) basis. S&P resolved its negative outlook on the sovereign rating in June of this year, simultaneously downgrading both the LC and FC ratings by one notch each to BBB+ and BBB- respectively.

While the risk that Fitch will downgrade South Africa’s credit rating is material given the negative outlook, we do not feel that the agency will resolve the outlook just yet. Back in October, the agency held a conference in Johannesburg titled “Fitch on South Africa”. At that conference, the agency discussed its current rationale concerning the ratings assigned to South Africa, as well as the revision of the ratings outlook to negative from stable in June. The agency stressed that the deterioration in SA’s creditworthiness has been a “fairly slow burn” – that is, gradual but unrelenting. However, Fitch noted that the revision in the outlook on the ratings to negative from stable on 13 June 2014 does not necessarily imply that a ratings downgrade will occur in the near future, as the agency has a “relatively long” two-year assessment period within which to decide. If we are right, we think that we could see the rand experience somewhat of a relief rally early next week. However, we think that the extent of any upside for the currency will be limited as markets will likely remain risk-averse ahead of the FOMC meeting.

Adding to ratings anxieties, Moody’s issued a note on South Africa earlier this week discussing the recent load-shedding and the negative implications this might have for economic growth next year. Moody’s pegs 2015 growth at 2.5%, but believes that the country’s electricity supply constraint “poses fresh risks for attaining [this rate of] growth”, particularly via the negative impact this might have on the mining and manufacturing sectors. They believe that the “decline in the country’s potential growth rate over the past five years is largely attributable to these [electricity supply] constraints”. While there is new build taking place, it is not expected to be complete for 3 – 4 years. The agency notes that “[t]he lack of reliable energy supply as well as the need for more efficient rail infrastructure and less congested ports are already deterring investment broadly throughout the economy”. Fitch and S&P are also likely to comment on South Africa’s electricity situation in their respective ratings updates. A negative tilt in comments made by either agency could also dampen any relief from an unchanged ratings view.

On the international data front, China’s industrial production data for November disappointed. Retail sales were slightly higher than expectations. Retail sales data came in at 11.7% y/y in November, up from 11.5% in October and higher than the consensus expectations of 11.5%. At the same time, industrial production disappointed, coming in at 7.2% y/y, down from 7.7% in October and lower than the consensus estimate of 7.5%. The average industrial production growth rate in 2014 is 8.3% (with only December still outstanding). This is well below the 2013 growth rate of 9.7%. In fact, this year industrial production in China looks set to record the lowest growth rate since 1990. While the base of industrial production is substantially larger, the decline is indicative of a production side in the China economy that continues to struggle. As pointed out before, this is on balance negative for commodity currencies such as the rand.

Eurozone industrial production is expected to rise a modest 0.2% m/m according to the consensus from the Bloomberg survey. There’s a slight skew to the downside with which Steve Barrow (our G10 FIC Strategist) would agree, although he is not looking for a significant miss. Steve points out that we have already seen some countries release their industrial production data and, in general, it has been underwhelming. Germany was up just 0.2% m/m and France was down a whopping -0.8% m/m. A downside miss may weigh on the euro slightly, but the reaction, if any, will probably be temporary.

US PPI data is expected to be pretty flat, with a -0.1% m/m headline fall and a 0.1% m/m core increase. The skew around the 0.1% core forecast is pretty symmetrical. Steve sees a risk that the number will be low, as we do with the headline figure. Clearly the headline number will continue to be impacted by the fall in energy prices. Steve doubts that the market is going to respond much, as investors may sit on their hands now ahead of the FOMC decision next Wednesday.

Whereas it might have been expected that oil price weakness would cause a delay in Fed policy normalisation, it seems as though the Fed might feel that things remain on course. At its 28 to 29 October meeting, the FOMC put paid to any views in the market that a fall in oil prices had significantly changed the committee’s view on inflation. The statement noted that while “inflation in the near term would likely be held down by lower energy prices and other factors”, it still assessed “the likelihood of inflation running persistently below 2 percent [as having] diminished somewhat since early this year”. Concerns over falling inflation expectations, which some Fed officials had expressed prior to the meeting, were also downplayed. The committee acknowledged that “market-based measures of inflation compensation have declined”, but added that “survey-based measures of longer-term inflation expectations have remained stable”. Last week, Fed officials Fischer (Vice Chair) and Dudley (President of the New York Fed) both stressed the growth-enhancing properties of lower oil prices. The Fed’s Beige Book (released last week after these comments) underscored this point, reporting that the fall in oil prices had helped lift consumer spending but had not, so far, led to any change in drilling activity in the shale gas industry. Fischer downplayed the deflationary risks, saying that the overall price impact of the oil price fall should prove temporary. Consequently, it seems as though the Committee might press ahead with changes to its language at next week’s FOMC meeting (16 to 17 December) – that is drop its commitment to keep rates low for “considerable time” and replace it with the pledge to be “patient”. Although the Fed’s language change might be modest and reasonably well anticipated, as we have seen all too often, even well-signalled and minor tweaks by the Fed can have major consequences for emerging market currencies.

The rand continued to weaken on Thursday and closed at USDZAR11.63 yesterday, compared with Wednesday’s close of USDZAR11.47. Rand depreciation against the dollar occurred in line dollar strength against most of the major crosses; the dollar strengthened against the euro and yen, but weakened against the pound. The rand weakened against all of the major crosses, with the biggest decrease seen against the pound (-0.9%) and the dollar (0.8%). The rand put in the second-worst performance amongst the commodity currencies we monitor, only ahead of the NOK and was the fourth-worst performer in the EM currency space, performing better than BRL, MXN and RUB. The rand traded between a low of USDZAR11.4700 and a high of USDZAR11.6567 intraday – this marks a six-year weak point for the rand against the dollar.

Commodities were mixed on the day. Copper was up by 0.7% and gold was up negligibly by 0.1%. Platinum fell, albeit also negligibly, by 0.1%. Brent declined further on Thursday, falling by 0.9% to a five-year low. The developed market MSCI was largely unchanged, while the MSCI EM were down on the day, by 1.3%. The ALSI was down by 1.3% on the day. The EMBI spread narrowed by 1 bps, while SA’s 5yr CDS spread narrowed by 2 bps. The CBOE VIX index, a volatility-based proxy for global risk appetite/aversion, increased by 8.4%.

Non-residents were net sellers of local equities (-ZAR215 million). Bond yields decreased by between 3 bps (R208, R186) and 5 bps (R203). The 6x9 FRA and 12x15 FRA increased by 2 bps, while the 3x6 FRA was unchanged.

FI

The biannual event of Fitch and S&P pronouncing on the sovereign’s creditworthiness takes place today. S&P is expected to comment after 6pm SA time, while Fitch will be at 11pm SA time. Both times are outside of market hours due to EU regulations. To reiterate our base case, we do not expect S&P (BBB- LT FC, stable outlook), nor Fitch (BBB LT FC, negative outlook) to change ratings. At the prior June announcements, S&P had downgraded South Africa and resolved the outlook to stable, while Fitch had moved the country to a negative outlook. The risk does however lie with a downgrade from Fitch, as per its negative outlook. However, we believe that the agency will wait till after February’s budget and the results of the public sector wage negotiations. Local bonds will only react to rating news on Monday morning but, with Tuesday being a local public holiday, we could see extremely low liquidity on the day and quite skittish behaviour.

Today also sees NT auction up to R800m across the I2025, I2046 and I2050 inflation-linked bonds. We expect fairly quiet trade today as the market looks ahead to this evening’s rating actions.

Yesterday saw bonds recover some of the weakness from Wednesday. The wings of the curve strengthened by 3.0 – 4.0 per bond, while belly bonds were around 1.00 bp stronger. The benchmark R186 strengthened by 3.0 bps. The currency weakened further on the day, which also pushed the FRA curve slightly higher. US Treasuries flattened as 2yr and 5yr USTs weakened and 10yr and 30yr UST strengthened.

Turnover was a decent R24.1bn in nominals and R2.1bn in ILBs. Heavy offshore selling of -R2.7bn yesterday. Large selling was seen across the R186 (-R957m), R214 (-R880m), R213 (-R450m), R2048 (-R282m), R2044 (-R254m), R158 (-R250m) and R204 (-R167m). The only offset was seen in the R207 (+R414m) and R2023 (+R2877m). The selling was possibly due to some pre-rating agency fears. We think that there could see a slight relief rally into next week if neither rating agency makes a move.

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