China is heading into what is traditionally a peak period for base metal demand. This is under threat at the moment given the COVID-19 interruptions and a generally softer economy. The PMI numbers released over the last week have not made for welcome reading, however it is expected that Beijing will come the rescue with additional stimulus programmes. China's PMI has dropped below the 50-point market in March, which separates growth from contraction on a monthly basis. The reading indicates the sharpest activity decline since the initial onset of the Covid-19 pandemic. China's declining PMI could potentially add some risk to the current global commodities outlook. The big question is how long can the country actually tolerate the “zero tolerance” covid policy.
Base metal prices are under pressure this morning in Asia as a rising dollar, tightening US monetary policy and China growth concerns all conspire to cage the bulls. The 3m LME copper benchmark is currently trading 0.9% down on the session at $10359.00/tonne, this after hitting a 4-week high yesterday of $10580.00/tonne. 3m Aluminium has also eased this morning, wiping out half of yesterday’s 0.5% gain.
Oil prices retreated yesterday after posting some early gains, as the EU avoided any bans on Russian crude, while a dollar surge on account of a hawkish Fed weighed further. Brent dropped back to around $104 per barrel after rising above $110 in early trade, although we are seeing a bit of a rebound this morning. EU Commission President von der Leyen has not ruled out banning Russian oil, suggesting that talks on the matter will continue. This, of course, will keep a notable risk premium baked into the oil markets, given the potential threat to market supplies at a time when demand already outstrips supply comfortably.
Africa: Ratings agency Fitch has warned that African banks' post-pandemic recovery could be derailed if global inflation jumps significantly and the global economy slows sharply on the back of the war in Ukraine. Fitch added that stagflation risks are increasing and that much higher commodity prices and weakening currencies will lead to materially higher inflation pressures on sovereigns and operation environments. Should stagflation set in, Egyptian and Jordanian banks appear susceptible to credit rating changes. According to Fitch, Egypt's vulnerabilities will exacerbate under the scenario because of its reliance on non-resident investments in its local bond market and inflows into its tourism sector for boosting international reserves. Meanwhile, banks in Ghana, Kenya and Tunisia are most likely to be downgraded as a second-round effect of the events in Europe makes their operating environments vulnerable to more shocks.
Nigeria: To help cushion Nigerian companies against the fallout of the war in Ukraine, the International Finance Corp, the World Bank's lending arm, plans to increase their funding. Senior country manager Kalim Shah was quoted as saying, "we will be stepping up our focus, especially around trade finance," to facilitate imports and exports of goods and services. The agency is also planning "several hundred million dollars of additional investment this fiscal year" in the country's infrastructure and financial sectors to support social services and firms hit by funding and supply-chain challenges. However, Shah stopped short of providing details of specific deals that are not yet public. Note that Nigeria imports refined oil products and much of its raw materials, and many of its companies are struggling with surging costs as a result of supply shortages triggered by the war in Ukraine. This had placed additional pressure on an economy that was already facing power, roads, and other infrastructure deficits estimated to be at $3bn by Moody's Investor Service.
West Africa: Aid agencies yesterday said that West Africa is facing its worst food crisis on record, driven by conflict, drought, and the impact of the crisis in Ukraine on food prices and availability. In a joint statement released yesterday by 11 international aid agencies, there are around 27mn people suffering from hunger in the region. That number could rise to 38mn by June, a 40% increase from last year and a record high. Countries most affected by hunger include Burkina Faso, Mali, Niger, Nigeria and Chad. Barring Chad, the countries mentioned above are facing Islamist insurgencies that have forced millions of people off their land.
Zambia: Fitch yesterday affirmed Zambia's long-term foreign-currency issuer default rating (IDR) at 'RD' and the long-term local currency (LTLC) IDR at 'CCC'. According to Fitch, the 'RD' rating reflects that Zambia has not serviced the bulk of its outstanding external debt since failing to make a Eurobond interest payment in October 2020. Furthermore, the affirmation of Zambia's 'CCC' LTLC IDR rating reflects that the government continues to service its local-currency debt. Factors that could lead to a negative rating in the LTLC include the government announcing clear plans to restructure its Kwacha-denominated debt, or it enters into a grace period on its local currency debt. The long term local currency rating would be downgraded to 'RD' in the event that the government defaults on local-currency debt before any restructuring announcement. Conversely, once Zambia reaches an agreement with bondholders on restructuring its long-term foreign-currency debt and completes the restructuring (for example, by issuing new bonds to replace the existing stock of bonds), Fitch will assign ratings based on a forward-looking analysis of the sovereign's willingness and capacity to honour its new foreign-currency debt obligations. Fitch also noted that it believes the timelines set out by the Zambian government to form a creditors committee, agree with private creditors, and final IMF Board approval of the ECF all within 1H22 are optimistic. Disagreements among official creditors or prolonged negotiations with private creditors could push the date of an eventual agreement back into H2 or 2023.
Forex: Nigeria's external reserves fall as the central bank ramps up support for the Naira
Data on reserves movement from the Central Bank of Nigeria (CBN) showed that the country's external reserves dropped by $971.4mn in the first quarter of the year. Specifically, the country's foreign exchange rate buffer fell to $39.55bn in Q1 from $40.52bn at the start of the year. Aside from the payment of debt service and the importation of refined petroleum products, the decline in reserves comes on the back of increasing CBN intervention in the forex market. Note that the high demand for dollars has put pressure on Nigeria's reserves which the central bank has used to defend the Nigerian Naira. Other measures the CBN has implemented included prohibiting the selling of dollars to exchange bureaus and prohibiting the broadcast of black market rates on FX platforms such as AbokiFX.
Not even the higher-than-normal oil prices have boosted Nigeria's reserves as Africa's largest crude producer is unable to fulfil its OPEC+ quotas due to crude theft and diversion of oil revenues to subsidize gasoline prices for its population. Nigeria's reserves declined despite the oil price rallying by more than 38% in Q1. Given the persistent scarcity of FX, we expect the CBN to continue to use reserves to defend the Naiara. Thus further downside risks exist to reserves in the coming months amid limited inflows.
Therefore, it is worth flagging that a continued decline in reserves and lingering oil production challenges suggest that the Naira could potentially face devaluation in the near term. According to our in-house indicators, the Naira is overvalued, suggesting room for depreciation exists.
Fixed Income: Global bond rout worsens on Wednesday as Fed scales up its tightening rhetoric
The sell-off in global bonds deepened on Wednesday as investors dumped bonds following a wave of hawkish comments from the Fed. The prospect of more aggressive tightening from the Fed pushed yields across the US Treasury curve higher as traders priced in the risk of steeper rate hikes. The bearish bias came after Fed member Brainard said that the central bank would continue tightening policy periodically, adding that inflation is concerningly high and that getting it down is the Fed’s top task.
Brainard said that the Fed aims to shrink its balance sheet by as soon as May while noting that the combination of rate hikes and the shrinking of the balance sheet should see monetary policy return to a neutral level by the end of this year. Brainard said that the Fed is watching the yield curve closely for signals of downside risk. The US Treasury curve has triggered a recession warning with the 10v2 spread, historically an accurate predictor of recessions, briefly inverting in recent days.
Fears of more aggressive tightening from the Fed saw the benchmark 10yr US Treasury yield rise 15bps to 2.55% on Wednesday, the largest upside move since the onset of the Covid pandemic in March 2020. The shorter-dated 2yr yield meanwhile rose 9bps to 2.52% on Wednesday, its highest level in more than three years. The bearish bias was not contained to US Treasuries, with bonds across the globe suffering notable losses yesterday. The JP Morgan EMBI Global Total Return Index, which we use as a proxy for the performance of emerging market bonds, closed the session lower on Wednesday as investors scaled up rate hike expectations in the face of soaring global inflation and the hawkish commentary from the Fed.
With the situation in Ukraine worsening, amplifying global supply chain pressures, we expect the broader bear flattening bias in the global bond market to remain intact, especially as the Fed tightening narrative is moved up in time and magnitude. It is looking likely that the Fed’s quantitative tightening will begin as soon as May, which will also reduce dollar liquidity in the global financial system, a factor that has up until now been supportive of riskier assets.
Macroeconomic: The ongoing war in Ukraine is dampening Sub Saharan Africa’s economic outlook
While much of the focus for investors remains centred on monetary policy given the inflation shocks being caused by the war in Ukraine, investors are also keeping a close eye on growth dynamics, especially after the US Treasury curve inverted this week, which historically has been an accurate predictor of recessions. Regionally, investors are focussed on the wave of PMI data released this week as it provides up-to-date insight into economic conditions in Sub Saharan Africa.
The latest PMI data confirms that the spike in the supply chain and inflationary pressures linked to the war in Ukraine is weighing on economic activity in the region. While still buoyed above the 50-point neutral mark, the Sub Saharan Africa regional PMI average fell from 52.4 in February to 50.8 in March. Looking at country-specific data, the decline in PMI was broad-based as soaring inflation pressures weighed on consumer demand. The most notable downward movements were seen in Uganda, Kenya, Nigeria and Ghana. It is worth noting that the only Sub Saharan African country whose PMI reading rose in March was South Africa.
South Africa’s economy-wide Standard Bank PMI rose to 51.4 in March, up from 50.9 in February, shrugging off the return of load-shedding and the impact of the Ukrainian war. Survey results showed that the increase in the headline reading was largely due to a renewed increase in employment (with the index having a 20% weighting). However, the rise in the PMI gauge masked a worsening of price and supply risks. Respondents were concerned about inflationary pressures as prices of several commodities surged, leading to the quickest increase in business costs for nearly six years. With firms being able to transfer these costs to consumers, this resulted in the second-sharpest uplift in selling prices since the survey began in 2011. Notwithstanding an end to the national state of disaster, the pace of South Africa’s private economy recovery faces risks from the zero-COVID policies in China, leading to stoppages in production and on key supply routes as lockdowns were reimplemented. Elevated inflation pressures, an unstable power supply and lingering structural challenges also threaten to hinder the private economy’s performance over the coming months.