The stabilisation in global markets proved to be short-lived as EMs were caught in the cross-currents of contagion, trade wars, and renewed dollar strength.
Tightening global liquidity continues to permeate markets and the escalation in trade tensions have started to impact the data. The economic surprise indices between the US and Europe have converged, suggesting the best of US growth is in the base. But with the Fed still going it alone in normalisation, the dollar keeps finding support. Yet a strong dollar should limit the upside to inflation, notwithstanding nascent signs of tariff pass-through and an ever-tightening labour market. Sentiment surveys have begun to roll over as the tax cuts run their course. Positioning favours a rally in US yields, which would be in keeping with ongoing safe-haven demand and a moderation in US activity momentum.
Not only has Trump threatened to raise the tariffs on the next US$200bn in China imports from 10% to 25%, but he has also verbally intervened on Fed hikes in a bid to limit dollar strength. His doubling of steel and aluminium tariffs on Turkey precipitated a currency crisis, which prompted heterodox policy responses to stabilise the lira. In contrast, Argentina hiked rates by 20ppt. Yet the lira and the peso both lost 25% against the dollar.
So what lesson is South Africa to learn from these examples, as the SARB is saddled with a renewed policy conundrum? The economy is in recession, inflation is accelerating, and the rand lost 11% against the greenback. In the past, the SARB would hike in the face of stagflation, but with fiscal tightening also underway and credit creation severely constrained by regulation the SARB may not need to do much to fight inflation.
It also does not help if policy makers in a small open economy with a highly traded currency and liquid capital markets decide to pursue a populist narrative while investors were expecting much-needed reforms. Rhetoric around expropriation without compensation continues to escalate, with the uncertainty likely to weigh on confidence and further delay investment. Thankfully, the fiscal position is holding the line in the face of economic weakness – this should be enough to keep the ratings steady.
Even so, South Africa still screens poorly on the standard credit metrics and so easily finds itself part of the next fragile five-letter acronym. We have gone from BRICS (Brazil, Russia, India, China, South Africa) to BRATS (Brazil, Russia, Argentina, Turkey, South Africa) and with normalising US yields, high-yield could mean “junk” rather than “carry”. Given the elevated risk aversion, the remainder of the year would seemingly imply tempered return expectations. Yet South Africa’s risk premium may again be excessive given the expected pause in ratings, SARB credibility, and a steady hand at the Treasury.
Market developments
The asset class performance reversed sharply in August with equities (2.3%) and listed property (2.2%) taking the lead by a wide margin. Floating rate credit (1.4%) outperformed cash (0.6%), but the rest of the fixed income spectrum declined during the month. The ALBI lost 1.9%, followed by fixed-rate credit (-0.7%) and inflation-linked bonds (-0.2%).
While the US dollar index (DXY) rose by only 0.6% in August, it belies notable variability during the month. The DXY reached a year-to-date peak of 96.7 mid-month (EUR/USD at 1.1342) amid worsening EM risk appetite and escalating trade frictions. While a moderation in US data and Trump’s displeasure with Fed hikes weighed on the greenback, the retracement towards the end of the month was too little to bail out EM FX, with the complex losing 6.2% against the dollar. The rand was one of the worst performing units, losing 10.8%, which was eclipsed by only the Turkish lira and the Argentine peso. At 15.30 the rand is around 15% undervalued relative to our fundamental fair-value estimate.
The US 10-year yield remains in a core 2.80% – 3.00% range as upward pressure from net supply is countered by safe-haven demand. The pressure on EM rates stemmed from rising credit risk premia and weakening exchange rates amid the spill-over selling from Argentina, Turkey and Brazil. SA rates sold off by 30bp – 40bp as inflation accelerated and the economy contracted. The R21bn in net foreign selling resulted in a R90bn peak-to-trough swing in year-to-date flows. The SA 10-year yield is trading moderately cheap versus our fair-value estimate of 8.80% – 9.00%.
