ZAR: Outperformance unsustainable - BBH

According to analysts from Brown Brother Harriman, the outperformance of South African assets can not continue as fundamentals worsen.

Key Quotes:

“Despite weak fundamentals, South Africa assets continue to outperform.  We not think this can be sustained, as this liquidity-driven rally can only go so far as the economic outlook deteriorates.”

“The economy remains sluggish. GDP growth is forecast to be stagnant in 2016 before it accelerates modestly to around 1% in 2017 and 2% in 2017 from 3.2% in 2015.  GDP contracted -0.2% y/y (-1.2% q/q annualized) in Q1.  This was weaker than expected, and points to downside risk to these forecasts.”

“Price pressures are still evident, with CPI rising 6.3% y/y in June.  This is the highest rate since March and suggests that the SARB will maintain a hawkish bias since inflation is still above the 3-6% target range.”

“The rand has performed well this year after a poor 2015.  Last year, ZAR lost -25% vs. USD and was one of the worst performers in a group that included ARS (-35%), BRL (-33%), COP (-25%), and RUB (-20%).  So far this year, ZAR is +9% YTD and is lagging only the best performers BRL (+21%) and RUB (+10.5%).  Our EM FX model shows the rand to have VERY WEAK fundamentals, so this year’s outperformance should ebb.”

“South African bonds have outperformed this year.  The yield on 10-year local currency government bonds is -101 bp YTD.  This is behind only Brazil (-458 bp), Indonesia (-173 bp), Peru (-158 bp), Russia (-104 bp), and Colombia (-102 bp).  With inflation likely to remain high and SARB potential resuming its tightening cycle, we think South African bonds will start underperforming.”