The market malaise intensified in May amid the confluence of a spike in US yields, higher oil price, weak activity data, geopolitics, and EM crises. The US withdrew from the Iran deal and implemented steel and aluminium tariffs on Mexico, Canada and the EU. While the initial trigger was the 3.12% print on the US 10-year yield, Italian politics and the economic strain in Turkey and Argentina exacerbated the risk aversion.
While SA has been basking in the light of pending reforms, developments in Turkey and Argentina reveal the dark side of imbalances and credibility deficits. Turkey’s economy has been burdened by high dollar denominated debt, overheating domestic demand, a large current account deficit, and rising inflation. The lira’s fall was belatedly met with a 300bp central bank rate hike. Argentina faces similar pressures, in addition to populist-driven fiscal deterioration. Despite hiking rates by a cumulative 975bp, Argentina was forced to turn to the IMF amid a run on the currency.
Can growth recouple to spur EM asset prices, increase global liquidity and weaken the dollar? Based on the May PMI run the evidence is mixed. In the absence of better growth prospects, EMs will have to rely on contained core yields driving capital back into high-yielding assets – yet another hurdle given Fed hikes and potential ECB taper.
Domestic tailwinds have largely run their course based on the trough in inflation, widening trade deficit, and less-certain GDP outlook. While political dynamics remain positive, policy uncertainty persists (mining charter, national minimum wage, land reform) and the fiscal position faces risks from SOEs, the wage bill, tertiary education spend, and water infrastructure demands.
The rand remains one of the EM darlings, but we are cautious on the fundamentals and global liquidity. While there are upside risks from higher petrol prices, elevated wage settlements, and vulnerabilities to the rand, inflation surprises have been to the downside, with partial pass-through from the VAT rate hike.
Numerous risks constrain the SARB. Despite a potential undershoot in growth this year, the MPC would need to see a further improvement in inflation expectations, delivery on fiscal consolidation, the absence of second-round effects, and a well-behaved rand. This will give comfort that inflation – the symptom of the policy stance – will remain close to 4.5%.
The last month of Q2 will remain challenging given the impending FOMC rate hike (13 June), potential ECB taper (14 June), and the risk of escalating trade tensions. The local data calendar is busy: Q2 BER Business Confidence Index (13 June), CPI (20 June), Q1 current account data (21 June), NERSA’s announcement on Eskom’s RCA application (21 June), finalisation of the government wage settlement (30 June) with the potential for a SAFTU strike (11 June).
SA markets showed broad-based weakness in May, with floating-rate credit the top performer at 1.6% total return. This was followed by cash (0.6%) and ILBs (0.12%). Listed property lost 5.9%, followed by equities (-3.5%), nominal bonds (-2.0%) and fixed-rate credit (-0.4%).
The US dollar index rallied 2.3% amid higher yields and risk aversion, while weak activity data and Italian political uncertainty weighed on the euro. The rand lost 1.9% against the US dollar, but rallied by 0.8% in trade-weighted terms. USD/ZAR remains in line with our fair-value range (12.50 – 13.00).
Geopolitical risks, trade tensions, and the stronger US dollar weighed on equity markets, with the MSCI All Country Index losing 0.2%. EMs bore the brunt of the pain, down 3.8% in dollar terms, while DM equities eked out a 0.3% gain. The MSCI South Africa index declined by 6.8% in dollar terms, underperforming the EM average. The SWIX lost 4.8% in May and is down 7.4% in total return terms year-to-date. That Ramaphoria has lost some shine is evident in the underperformance of SA Inc – financials lost 6.3% and consumer goods 4.3% – while resources rose by 2.2% thanks to rand weakness and higher commodity prices. The MSCI South Africa index forward PE dropped to 14.4 times, largely due to pressure on financials. Following seven consecutive months of inflows, non-residents sold R20bn of equities.
Higher US yields, rand weakness, and EM contagion pushed SA’s 10-year yield higher by 40bp, to 8.75%. The sell-off was in line with the high-yield EM peer group. The risk re-pricing was notable in the local currency bonds, with the SA/US 10-year yield spread widening by 50bp, to 570bp. The movement in the credit spread was more muted based on the 10-year CDS (+10bp to 270bp). Non-residents have turned net sellers of SA bonds, disinvesting R30bn in May, taking the year-to-date flows to –R6bn. At 8.80% the 10-year yield is screening cheap and breakeven inflation has widened to 6.20%.