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Zambia Market Watch – Global focus on ECB rate decision

July 22, 2021by Nicholas Kabaso
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Local Market Commentary

  • Zambia yesterday received over 150k doses of the Johnson & Johnson (J&J) vaccine from the US under the Covax facility.  Ministry of Health Permanent Secretary for technical services Kennedy Malama told reporters that more vaccines from the US are coming and that the J&J consignment would be targeting provinces that are “taking up the vaccine fast.”
  • Note vaccine hesitancy in populations and widespread infrastructure failures in Sub-Saharan Africa are some of the reasons that have been attributed to the slow pace of vaccination compared to the global average. With most Sub-Saharan African countries lagging behind in terms of vaccination rates, risks of repeat waves of infections exist and continue to cloud the near-term growth outlook.
  • The big news across the base metal counters this morning is the declaration of force majeure by Berzelius Stolberg, a major lead smelter in Germany halting operations due to the severe flooding in the country. The company is the primary smelter of lead in Europe and its clo-sure has led to a spike in lead prices. 3m LME Lead surged to a three year high yesterday closing at $2336/tonne after touching $2350/tonne earlier in the session.
  • The premium of cash lead over its 3m forward is currently trading at $17.50/tonne, a 3-week high.  which shows the near-term supply crunch caused by the outage of  Berzelius Stolberg
  • Meanwhile, copper finished yesterday in the green and has gained incrementally this morning following the news that the second Chi-nese sale of state reserves was less than expected. China announced that they will sell 30 000 tonnes of copper and other base metals next week Thursday (29th July) as part of the programme to smooth excessive price pressures and volatility.
  • The main event of the session today will be in Europe with the ECB setting rates. The central bank will likely commit to its new forward guidance in keeping rates constant until inflation forecasts reach or surpass 2%. This would be a change from the previous policy which called for price increases to converge towards but remain below, the target of 2%. This will hold implications for the dollar, which tends to appreciate when the ECB promises loose policy. This could feed into the more bullish bias on the dollar and, by extension, support USTs. The 10y has meanwhile rebounded from recent lows and what technical analysts would call an “overbought” position, as investors reas-sess the outlook for the dollar. A dovish ECB message could change this dynamic for now, with the potential for a move down to the 1% mark not off the table when considering that global growth uncertainties are rising again.
  • There will also be some important US macro data up for release with jobless claims, some housing sector data, consumer confidence, and a leading indicator up for release. Investors will remain sensitive to the idea that the US economy could be running out of steam. The Citi economic surprise index suggests that US data outcomes have been mixed at best with a reading of 12 well below levels closer to 250 seen around August last year. This suggests that the outlook for a sharp recovery in economic activity is moderate, with the compression in Fed rate expectations as seen in OIS futures generally reflective of this.
  • In the FX markets, consolidation was the order of the day as the Kwacha closed little-changed. Meanwhile, the USD shed ground over-night as risk appetite revived following strong earnings reports on Wall Street. That said, we are trading only marginally off multi-month highs for the USD Index which hit 93.194 yesterday so the market is far from convinced that the risk is off the table, infact we would sug-gest that what we have seen is potentially some position squaring ahead of the ECB decision on rates later today. The general view is that the ECB will remain uber dovish which will prompt dollar longs into action once again with the macro driver being general policy diver-gence between the Fed and the ECB.

Rand and International FX Commentary

  • After some further intraday weakness at the start of the day, the ZAR managed to pull back and reverse losses against the US dollar as the greenback’s rise this week showed signs of easing. As broader market sentiment improves, haven currencies such as the USD and the Japanese Yen will begin to fall out of favour while riskier currencies advance. The ZAR was ultimately able to capitalise on improving risk appetite as it secured its first daily gain this week, appreciating 0.35% to 14.5750/$.
  • The ZAR’s weakness of late has come hand in hand with rising implied volatility levels. Implied volatilities, which measure the cost of hedging rand weakness, have steadily climbed since June, with the rise in shorter-dated contracts outpacing that of longer-dated ones. Specifically, at-the-money volatility for the one-week option is at its highest since March amidst global risk aversion and the upcoming SARB rate announcement, while implied volatilities for longer tenors appeared to steady yesterday. This suggests traders see greater near term volatility and potential weakness for the currency.
  • Despite paring losses later in the session yesterday, the ZAR shrugged off a CPI print that showed inflationary pressure moderated in June and will likely continue in the coming months as base effects are filtered out. The headline inflation print fell to 4.9% y/y in June from 5.2% y/y in May. Core CPI, meanwhile, edged marginally higher to 3.2% y/y from 3.1% prior. Despite headline inflation remaining above the SARB’s target range midpoint of 4.5%, core CPI increases continue to suggest there has been limited inflation pass-through on broader goods prices.
  • Given these dynamics, this ultimately sets up the SARB to keep rates on hold for the remainder of the year in order to support the econ-omy. However, risks to this outlook include significant currency weakness that could ignite cost-push inflation or otherwise prompt SARB action to stabilise markets. As such, today’s rate announcement is not expected to offer any immediate changes, with the focus to fall on forward guidance instead. Should the SARB display an overly dovish tone given recent developments, this could see a kneejerk reaction as market pricing continues to suggest rate hikes by year-end, with the ZAR likely to come under pressure in this case.
  • Alongside a domestic rate announcement, global markets will also look to the European Central Bank’s rate announcement. Given the ECB’s recent policy wording change, expectations are for an announcement that it will expand or extend its asset purchase program. A dovish ECB should bode well for market risk appetite in the day ahead and lift riskier assets, but will also likely weigh on the euro and thus support the USD on a trade-weighted basis. As for the ZAR, the local unit may trade more cautiously than the rest of the EM currency sample ahead of the SARB announcement. This has been the case during the Asian trading session this morning, with the ZAR hovering near yesterday’s close, failing to capitalise on broader risk-on moves.

Nicholas Kabaso

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