National budget speech 2020: Local markets outlook and trading opportunity

Local markets assess ratings outlook after the National Budget Speech

In this article we look at how local financial markets, including the rand and JSE listed equities, have reacted to the National Budget Speech, highlighting the key takeaways as well as what to expect from Moody’s Investor services in the upcoming ratings review.

Positive market reactions to the Budget Speech

Domestic financial markets responded positively to Finance Minister Tito Mboweni’s National Budget Speech.

Into the close of business, the rand had gained more than 1% against a firm dollar, in contrast to its emerging market and BRIC (Brazil, Russia, India and China) currency peers which were under pressured from macro concerns.

As the currency strengthened, local bond prices gained, and yields declined. The below chart shows the initial USD/ZAR reaction to Finance Ministers National Budget Speech.

Improved sentiment and currency strength were met with strong gains on SA Inc. shares (shares deriving majority of earnings from the domestic market). Local banking counters reacted most favorably to the news, with industrial counters, more specifically retail counters posting strong gains on the day as well.

The chart below shows the JSE sector moves on the day of the budget speech (26 February 2020).

Short-term market catalysts stemming from the Budget Speech

Treasury’s efforts to try reducing expenditure, while not increasing the personal and corporate tax burden, has been amongst the highlights for domestic financial markets in the National Budget Speech.

Government will now look to contain expenditure primarily through a R160 billion cut in the public sector wage bill over the next three years. The move becomes the primary initiative towards fiscal consolidation.

While Eskom remains a burden on the fiscus, there has been no additional provisions for the ailing State-owned Enterprise (SOE).

Ongoing concerns for markets

The outlook for economic growth has been revised lower and the fiscus will remain pressured. Soft employment and wage growth are expected to continue the collection shortfall, with the budget deficit expected to peak at 6.8% of GDP in FY20/21.

Debt servicing costs remain a significant proportion (15%) of Treasury’s expenditure budget detracting from what could be further spending on growth initiatives such as infrastructure spend which has been lowered over the next two years.

Unfortunately, SA Inc. counters such as banks and industrial counters are unwinding gains the day after the budget release. These companies whose respective earnings are linked to the economic health of South Africa are now balancing the domestic concerns with the macro concerns (such as the coronavirus) which threaten the global outlook as well.

Can a ratings downgrade be averted?

Moody’s Investor Relations are set to review South Africa’s sovereign credit rating on 27 March 2020. The agency currently has South Africa’s local currency debt 1 notch above sub-investment grade (junk) with a negative outlook.

Moody’s has recently lowered its economic growth forecasts for South Africa and would be attentive to the details of the latest national budget.

Deteriorating SOE finances, power outages, weak economic growth and growing deficits would be net negative for local credit ratings, although plans of fiscal consolidation would provide some positive impetus to the decision.

Moody’s has historically been more patient than its peers in terms of altering its credit ratings on sovereigns. While the economic outlook for SA has deteriorated, the ratings agency may look to see if the suggested reforms can be successfully implemented.

With the health of the public purse now largely dependent on the ability to lower the public sector wage bill, politics is the likely catalyst for the implementation and determination of South Africa’s rating fate. Bond markets and the ZAR do however suggest that a ratings downgrade in either March or November this year is South Africa’s ratings destiny.

How to trade the Rand?

Unfortunately gains in the rand have been short lived as dollar strength and rand weakness has renewed. The short-term positive sentiment stemming from the Budget Speech has started to be erased as markets turn their attentions back to the global macro catalysts in place, most notably the coronavirus outbreak and its effect on global growth. The rand being a highly liquid emerging market currency often serves as a barometer for risk sentiment which is elevated at present.

The USD/ZAR (Daily chart)

The USD/ZAR is fast approaching the R15.45/$ mark after having broken resistance at R15.10/$. Short term traders might look at short term pullbacks for long entry into the USD/ZAR, or alternatively wait for a break of the R15.45/S level. A break above R15.45/$ (confirmed with a close) would consider R15.70/$ a further upside target.

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