Normally, the South African Reserve Bank (SARB) Financial Stability Report (FSR) is a formality, with media taking little interest in its content and even less interest in reporting on it. This week, however, a rather worrisome inclusion in the report made the headlines and left a hollow feeling in the stomachs of many South Africans.
Key themes for this week include:
- SARB highlights increased risks of secondary sanctions
- The United States (US) debt ceiling deal brightens the mood across equity markets
- US Interest rate expectations are mixed ahead of June rate announcement
ARE WE AT RISK OF SANCTIONS?
The controversial relationship between Russia and South Africa has been making headlines for a few weeks, with growing tension between the West and South Africa on display for everyone to see. While many South Africans question what the repercussions of South Africa’s relationship with Russia could be, SARB provided some clarity on the question this week. In its bi-annual (twice yearly) FSR, SARB included a section on the increased risks of secondary sanctions on South Africa, and what it means for the financial stability of the country.
What exactly are secondary sanctions? Secondary sanctions are economic measures imposed by one country, as a punitive measure, for actions or policies that violate international norms or agreements. They are called “secondary” because they target third parties, such as individuals or companies from other nations that do business with the targeted country. The goal of secondary sanctions is to increase the economic pressure on the targeted country by limiting its access to international markets and resources.
In the FSR, SARB highlighted the following potential risks to South Africa:
SARB noted that should secondary sanctions be imposed on South Africa, the immediate impact would be the tightening or termination of correspondent banking relationships and increased costs of cross-border payments. This would impact many countries in the South African Development Community who depend on South African banks for cross-border transactions.
Possible removal of South Africa’s Continuous Linked Settlement (CLS)
The rand is the only BRICS (Brazil, Russia, India, China, South Africa) currency which is part of the 18 currencies that participate in the CLS system which is regulated and supervised by the Federal Reserve Bank of New York. SARB notes that should secondary sanctions be imposed on South Africa, pressure could be placed on the CLS banks to remove the rand from the system, which would expose South African banks to principal risks when settling foreign exchange transactions in CLS currencies. This in turn would increase settlement risk for South African banks.
Trade relations risk
South Africa’s trade relations with some our largest trading partners, such as the United States (US) and United Kingdom (UK). South Africa faces the risk of losing some of its favourable trade terms, which will have a detrimental effect on South Africa’s export market. One of the key concerns is the exclusion of South Africa from the AGOA (The African Growth and Opportunity Act), US legislation enacted in 2000 to support and encourage economic development in Sub-Saharan Africa. AGOA allows for duty-free and quota-free access to the US market for over 6,000 African products, including textiles, agricultural products, and handicrafts. It also provides for technical assistance and capacity building to help African countries improve their infrastructure, economic policies, and governance.
Risk of financial crisis
SARB also stated that sanctions “will be catastrophic for the South African economy and has the undeniable potential to trigger a financial crisis” for the following reasons:
- The South African financial system will not be able to function if it is not able to make international payments in US dollars. The impact of this on the economy and financial markets will be far-reaching.
- More than 90% of South Africa’s international payments, in whichever currency, are currently processed through the SWIFT international payment system. Should South Africa be banned from SWIFT because of secondary sanctions, these payments will not be possible.
- As a country with low domestic savings and a current account deficit, South Africa is highly dependent on foreign investment inflows to fund this deficit. South Africa is already plagued by foreign investment outflows as a result of its weak economic conditions and the recent greylisting. Jeopardising remaining investment inflows, which come predominantly from the US, European Union (EU) and UK, could therefore lead to financial instability.
Currently, the probability of secondary sanctions, and exactly what they would entail remains unknown, many economists and analysts however believe that there is a low probability for the exclusion of South Africa on international payment systems, while they deem the risk of fallout on favourable trade terms much higher.
DATA IN A NUTSHELL
The number of Americans filing for unemployment benefits rose by 2,000 from the previous week to 232,000 in the week ending 27 May, the most in one month, but below market forecasts of 235,000. The figure also remained well below the elevated levels of March, consistent with recent data indicating a persistently tight labour market in the US economy. The ISM Manufacturing PMI (purchasing managers’ index) fell to 46.9 in May from 47.1 in April, compared to forecasts of 47. The reading pointed to a seventh consecutive month of contraction in the US manufacturing sector. Timothy Fiore, Chair of the ISM Manufacturing Business Survey Committee said, “Companies are managing outputs to better match demand for the first half of 2023 and prepare for growth in the late summer/early fall period. However, there is clearly more business uncertainty in May.”
The economic sentiment indicator in the euro area declined to 96.5 in May, from a revised 99.0 in the previous month, falling short of market expectations of 98.9. Morale hit its lowest level since November 2022, as the economy remained stagnant in the face of high inflation and the rapid increase in interest rates. Sentiment has deteriorated among manufacturers, service providers, retailers, and constructors. On the other hand, confidence among consumers was largely unchanged. On the price front, the consumer inflation expectations index dropped to 12.2 in May, the lowest since October 2020, while the gauge for selling-price expectations among manufacturers decreased to 6.6, their lowest level since November 2020. The seasonally adjusted unemployment rate in the euro area edged down to 6.5% in April, the lowest rate on record. The latest figure represented a drop from last year’s rate of 6.7% and pointed to a tight labour market. The number of unemployed people declined by 33,000 from a month earlier to 11.088 million, its lowest level since comparable records began in 1995.
In China, the official NBS Manufacturing PMI unexpectedly fell to a five-month low of 48.8 in May from 49.2 in April, missing market estimates of 49.4. The latest print also pointed to the second straight month of contraction in factory activity, amid weak domestic and global demand.
South Africa’s private sector credit increased by 7.1% year-on-year in April, undershooting market expectations of 7.3%, and edging down from a 7.2% growth in the previous month. It was the 22nd consecutive month of growth in private sector credit, but at the softest pace since July 2022. Meanwhile, expansion in the broadly defined M3 measure of money supply rose 10.1% in April, above market forecasts of 8.6%, and increasing from an 8.9% gain in the previous month. South Africa recorded a trade surplus of R3.5 billion in April, undershooting market estimates of R4.95 billion and a downwardly revised R6.3 billion in the previous month. Exports tumbled 14.5% from a month earlier to R163 billion, mainly due to lower shipments of precious metals & stones, down 30%; machinery & electronics, down 22%; base metals, down 14% and vegetable products, also down 14%. Among trading partners, overseas sales decreased by 15.9% to Europe, 13.4% to Africa, 12% to Asia and 7.6% to America but rose by 2.5% to Oceania. Meanwhile, imports fell at a slower 13.5% to R160.3 billion, amid sharp declines in purchases of mineral products, down 34%; vehicles & transport equipment, down 25%; wood pulp & paper, down 30% and chemical products, down 12%. Meanwhile, the seasonally adjusted Absa Purchasing Managers’ Index fell to 49.2 points in May, from 49.8 in the previous month. The latest reading pointed to the fourth consecutive month of contraction in manufacturing activity, amid a sharp deterioration in the business outlook, to its weakest level since early 2020, amid the ongoing power crisis in South Africa.
DEBT CEILING DEAL IMPROVES THE MOOD
The Dow Jones dipped nearly 200 points on Thursday, dragged down by a 7% drop in shares of Salesforce after the cloud-based software company reported higher capital expenses than expected. Both the S&P 500 and the Nasdaq traded largely sideways as the AI-tech rally took a breather. Shares of AI company, C3.ai Inc. plunged about 22% after a disappointing sales outlook. Recent remarks from some US Federal Reserve (Fed) officials suggested the Fed could pause rate hikes this month. Around 71% of investors continue to expect borrowing costs to be left steady. Meanwhile, traders welcomed the passage of the Fiscal Responsibility Act of 2023 by a vote of 314 to 117 in the House of Representatives. The bill is now headed to the Senate and is expected to be approved before the 5 June default deadline.
European stocks rebounded from Wednesday’s two-month lows, with Germany’s DAX 40 index experiencing a gain of approximately 1% and the region-wide STOXX 600 advancing by 0.9%. Investors responded positively to data indicating that inflationary pressures in the eurozone cooled more than expected in May, alongside a tight labour market within the region. Furthermore, optimism was fuelled by the news that the US House of Representatives had passed a bill to suspend the debt ceiling, garnering significant bipartisan support. Among single stocks, shares of German software maker, SAP, were slightly up despite slowing revenue growth at Salesforce, while fashion retailer Hugo Boss also got some support from a surprise quarterly profit from US department store chain, Nordstrom.
Japan’s Nikkei 225 Index jumped 0.84% to close at 31,148 while the broader TOPIX Index gained 0.88% to 2,149 on Thursday, recouping losses from the previous session in a broad market rebound. Indications that the Fed could pause its interest rate hikes in June and the passing of the US debt ceiling bill in the House of Representatives also aided sentiment. Moreover, investors digested data showing Japanese manufacturing activity turned expansionary in May.
The local JSE FTSE All Share index rose as much as 1% to around 75,820 on Thursday, after two sessions of declines, tracking a positive mood across international markets. Market sentiment was boosted by positive news from the US following the passing of a bill to suspend the $31.4 trillion debt ceiling in the House of Representatives, as well as comments from Fed officials on a possible pause in monetary policy tightening. On the corporate front, the main support came from heavyweight tech companies Naspers and Prosus, financials, industrials, and resources.
GOLD LOOKING FOR DIRECTION FROM THE FED
West Texas Intermediate Crude futures steadied above $68/barrel on Thursday after losing more than 6% in the past two sessions, “black gold” remains under pressure as a surprise build in US crude inventories and signs of weaker Chinese demand weighed on the market. Data from the American Petroleum Institute showed that US crude stockpiles jumped by 5.202 million barrels last week, defying expectations for a 1.22-million-barrel decrease. Meanwhile, markets are bracing for the upcoming 4 June meeting of expanded Organisation of the Petroleum Exporting Countries, OPEC+, where investors remain split on whether the group would cut production further following mixed signals from key officials.
Gold steadied above $1,960/ounce on Thursday, holding onto recent advances as traders reassessed the US Federal Reserve’s interest rate outlook. Fed Governor and vice chair nominee, Philip Jefferson, said on Wednesday, “Skipping a rate hike at a coming meeting would allow the Committee to see more data before making decisions about the extent of additional policy firming.” He added that any decision to hold rate steady should, however, not be viewed as the end of the tightening cycle. Markets have now trimmed the chances that the Fed will raise rates by 25 basis points to only 26%, just a day after predicting a 67% chance of a hike.
Copper futures approached the $3.70/pound mark, rebounding from the six-month low of $3.50 touched on 24 May as mounting supply concerns and expectations of government stimulus outweighed evidence of low purchasing activity. Major market players continued to flag concerns that copper supply cannot keep up with expectations of long-term demand, as the metal is a key raw material for the transition to renewable resources. Copper inventories at the Shanghai Futures Exchange fell to under 135,000 tonnes in May, their lowest level this year, and those at the London Metal Exchange were under 60,000 tonnes, their lowest level since 2005. In addition, Chile said this year’s output is estimated to sink as much as 7% after the 10.6% decline in 2022. In the meantime, concerning manufacturing activity and industrial growth figures out of China ramped up bets of incoming stimulus measures from the Chinese government.
EURO AND STERLING RECOVERS AGAINST THE GREENBACK
The US Dollar Index fell below 103.9 on Thursday, its lowest level in nearly a week, as fresh data and comments from some Fed officials raised bets the Central Bank will pause the tightening cycle when it meets in about two weeks, following comments from Fed Governor, Philip Jefferson, and Philadelphia Fed President, Patrick Harker, who suggested the central bank would skip a rate hike in the next meeting.
The euro has rebounded above $1.07, attempting to recover from recent lows of $1.0633 reached on 31 May, as investors digested the hawkish comments made by European Central Bank (ECB) President, Christine Lagarde, and their implications for the future path of monetary policy. Lagarde stated that eurozone inflation remains too high, emphasising the need for further monetary policy tightening by the ECB. In contrast, other policymakers, such as Vice-President, Luis de Guindos, and Bank of France governor, Francois Villeroy de Galhau, mentioned that rate hikes were starting to impact inflation and upcoming interest rate increases would be minimal.
The pound sterling rose back above $1.24, recovering from a two-month low of $1.2306 reached on 25 May, bolstered by expectations of additional interest rate hikes by the Bank of England. While the UK’s annual inflation rate dropped to 8.7%, marking its lowest level in over a year, it still surpassed market expectations of 8.2%. Notably, the core inflation rate, which excludes food and energy prices, surged to 6.8%, reaching its highest level in 31 years.
The South African rand touched a new record low of R19.92/$ before recovering to close at R19.61, as growing concerns about South Africa’s relationship with Russia, alongside domestic economic risk, continued to weigh on the local unit. The currency faced yet another setback following the South African government’s decision to grant diplomatic immunity to participants of upcoming BRICS meetings in the country, including Russian President, Vladimir Putin. The warning from the South African Reserve Bank about the potential adverse effects on financial stability if secondary sanctions are imposed further damped the mood. South Africa continues to grapple with prolonged and intense load-shedding, which poses a significant risk to the country’s economic outlook.
The rand is trading at R19.53/$, R21.04/€ and R24.48/£.