Market stress eased over the course of September as the dollar retreated and risk aversion subsided. Yet this attempt for EM assets to stabilise belies persistent underlying risks relating largely to the impact on growth and inflation from the ongoing trade battles. While the latest round (10% on US$200bn) had little market impact, participants may be ignoring the medium-term risks from shifting supply chains and higher US consumer prices on incomes. The Fed remains steadfast in its gradual normalisation. Powell omitted the reference to “accommodative” and the Fed still sees the peak at 3.5%. For the Fed to continue tightening growth will need to hold up. Tax cuts and fiscal stimulus limit the near-term risks to US growth. But the combination of weaker EM growth and a strong US dollar will at some point hurt US corporates and so too the equity market. This will probably be the signal to the Fed to stall. Policy makers have responded to slowing Chinese growth with more easing, based on the weaker yuan and another 100bp RRR cut. Further weakness will very likely prompt more aggressive stimulus from China, which could perversely bail-out other EMs.
Locally policy uncertainty persists with the Constitutional Review Committee asking for yet another extension of its deadline, this time to November. The Zondo Commission on State Capture and the SARS enquiry continue to elucidate the extent of work needed to undo the systematic weakening of various SA institutions. With institutional strength a positive pillar for SA’s credit rating, Moody’s commentary pointing to a stable rating for the next 12 months at least would suggest that the review on 12 October should be a non-event. However, with Finance Minister Nene now caught in the Gupta fray, there is renewed focus on Moody’s and the political juggling that President Ramaphosa needs to do. This development is most unwelcome with only two weeks to go to the Medium Term Budget Policy statement, making it an exciting prospect as to who will present it and how government will fund the stimulus package in a deficit neutral manner. We think a credible story from Treasury will only buy time given the steady increase in debt to GDP and the risk of larger weekly bond auctions somewhere down the line.
Inflation is back in focus given the downside surprise in the August release, which coupled with the technical recession, tipped the odds in favour a pause at the September MPC meeting. With Brian Kahn having retired, the composition of the MPC tilts towards the hawkish side. Hence, it is easy to see the 4:3 vote for no change in September ending up as a 3:3 vote in favour of a hike in November if the rand is still perceived as a risk. On this score the domestic uncertainties will be compounded by global events, in particular the Iran sanctions (4 November) and the US mid-term elections (6 November), as well as ongoing downward revisions to GDP growth, particularly in EMs.
Market developments
In SA, fixed income delivered positive total returns in September with fixed- and floating-rate credit each delivering 0.8%, while cash (0.5%), inflation-linked bonds (0.4%) and nominal bonds (0.3%) also posted modest returns. The laggards were listed property (-2.6%) and equities (-4.2%). For 3Q18 only fixed-rate credit (1.9%) managed to beat cash (1.7%), with floating-rate credit (1.4%), nominal bonds (0.8%) and inflation-linked bonds (0.5%) lagging the other fixed income sectors. Listed property lost 1.0% during the quarter, while equities were 2.2% lower.
The recovery in EM assets and portfolio flows has been muted. The gyrations in the dollar and the contagion from Argentina and Turkey left EM FX down 4% versus the dollar for 3Q18. The rand was hit by the market turmoil – while the unit gained 4% in September, it was still down 3% for the quarter. The rand’s status as high vol/high beta was confirmed with USD/ZAR trading below 13.50 in July and above 15.50 mid-August and early-September. The rand has, for now, settled in line with our updated fair-value estimate around 14.00 – 14.50.
After trading in a core 2.80% – 3.00% range, the US 10-year yield has again breached 3.0% amid a shift in the supply/demand balance. Issuance has been rising while the Fed has continued to shrink its balance sheet. Moreover, the increase in bund yields (from 30bp to 55bp) has at-the-margin reduced demand from offshore given higher hedging costs resulting from Fed hikes. The rise in US yields has so far not had an adverse impact on local currency bond yields, with most markets posting modest gains towards the end of September. Higher US yields will be a risk to EM rates only if they are followed by further dollar strength. The SA 10-year yield traded between 8.75% and 9.50% during the quarter – at 9.50% the market is cheap compared to our fair-value range of 8.80% – 9.00%.
Global equities posted wide-ranging price returns in September, with the Nikkei up by 5.5% and the Shanghai Composite up by 3.5%. The FTSE100 rose by 1.1%, while the S&P500 managed a 0.5% increase. The MSCI World Index rose by 0.4%, while the MSCI EM Index declined by 0.8%. The MSCI SA Index was a laggard, losing 6.0% during the month versus -5.3% for the ALSI and -4.6% for the SWIX. Losses in pharmaceuticals (-40%), household goods (-18%), autos (-15%), healthcare (-14%), beverages (-13%), and personal goods (-11%), were only partly offset by gains in industrial metals and mining (+20%). Despite the recovery in the exchange rate, resources (-0.3%) outperformed financials (-3.1%) and industrials (-7.0%). The latter was plagued by company specific weakness, for example concerns about Aspen’s debt after weak results, a weaker outlook from Netcare, and ongoing strain between MTN and Nigerian regulators.
