Shifting dynamics made April an uneasy month for markets: from a de-synchronisation in global growth to a reversal in the US dollar and a slump in portfolio flows to EMs. Geopolitics remained front and centre, moving from strained US-Sino relations, to the US imposing sanctions on various Russian entities, culminating in a historic summit between North Korea and South Korea that hopes to end the 65-year old Korean War armistice.
Softening growth in Europe and China resulted in diverging monetary policy expectations and a sharp rebound in the US dollar. With the US 10-year yield peeking above 3.0%, wider interest rate differentials boosted the greenback, hitting EM FX and bond markets amid a reassessment of the search for yield.
The optimism on South Africa’s nascent reform – evident in record-high consumer confidence in 1Q18 – was not enough to buffer markets from global cross-winds. The rand underperformed most of the EM peers, losing 4.5% against US dollar and 3.2% on a trade-weighted basis during April. This partly reflects a catch-up from an overvalued position, leaving the currency close to fair value.
While political developments remain positive – Denel’s new interim board, the signing of the IPP deals, and the president’s investment drive, amongst others – some domestic factors have become less certain. The implementation of the National Minimum Wage has been delayed, the public sector wage negotiations are on shaky ground, SA did not receive an exemption from US steel and aluminium tariffs, and the current account balance may be deteriorating anew.
Notwithstanding the reset in the rand and the VAT hike, the inflation outlook remains benign – CPI inflation fell to a seven-year low of 3.8% in March thanks to moderating food price inflation and contained core inflation. The impact of the higher oil price will be countered by low food price inflation, and outside of the US, global inflation has been surprising to the downside, suggesting little to fear from import prices.
The biggest domestic risk to the SA economy and markets resides with the financial stability of SOEs, in particular Eskom. Eskom’s credit ratings remain on negative outlook subject to the outcome of the Regulatory Clearing Account process (due end-June) and funding. Even so, S&P will very likely sound more upbeat on the sovereign in its 25 May review, but not enough to change the BB/stable outlook. Before then the market will focus on the VAT impact on SA CPI (23 May), the Fed FOMC minutes (23 May), and the SARB MPC announcement (24 May).
Market developments
The ALBI lost 0.7% in April amid rand weakness and elevated domestic concerns. Given ongoing disinflation and attendant weakening in demand, ILBs were the worst performer at -2.6% in April. Listed property was top for the month, gaining 7.7%, followed by equities at 5.4%, and cash at 0.6%.
The net sell-off in the SA 10-year yield kept pace with the 20bp rise in the US yield, leaving the SA/US 10-year yield differential trending around 540bp. SA’s 5-year CDS spread widened by 15bp, in line with its high-yielding credit rating peers. On balance, the strain of the US bond market sell-off was more evident in EM dollar credit spreads than in local currency spreads. Following robust inflows in 1Q18, non-residents turned modest net sellers of SA bonds in April (-R0.3bn) – this was more on account of profit taking early in the month than concerns around EM risks later in the month. While near-term risks are elevated, the inflation fundamentals remain benign and give the SARB room to manoeuvre down the line. At 8.50%, the 10-year bond offers over 3.0% real yield and is fairly priced for risk on our bottom up valuation.
Notwithstanding elevated geopolitical tensions and higher US yields, the VIX retreated and DM equities rebounded. The S&P500 eked out a 0.3% gain, while the FTSE100 jumped by 6.4% and the Eurostoxx 50 rose by 5.2%, both benefiting from weaker exchange rates. Global equities gained 0.8% in April with DMs outperforming EMs by 1.6% in US dollar terms. The MSCI South Africa index gained 3.7% in local currency terms, beating EMs by 2.6%, but in dollar terms SA was an underperformer, losing 1.6% vs. 0.6% for EMs overall. The JSE gained 5.4% while the SWIX rose by 4.3%. The weaker rand and higher commodity prices (despite dollar strength) boosted resources counters. Chemicals (10.1%) and mining (8.6%) outperformed, while technology (-4.0%), beverages and tobacco (-1.4%), and general retailers (-1.1%) underperformed.
