South Africa continues to bask in “Ramaphoria”, shaking off the spike in global market volatility and escalating international trade tensions. While the ALSI came under pressure from the global equity market sell-off, the currency and bonds posted gains on the back of ex-President Zuma’s resignation, the positive views on the 2018 budget, and a cabinet reshuffle.
The delay in the State of the Nation Address (SoNA) gave rise to speculation of a Zuma-recall, but markets were kept on tenterhooks as the ANC NEC, Top Six, NWC, and Zuma to-ed and fro-ed on the matter. The biggest fear was a potential delay in the budget, which would easily have triggered a Moody’s downgrade. However, once Zuma resigned (14 February), things moved swiftly. President Ramaphosa deliver the SoNA to many an ovation, the budget delivered, and we received a new (old) Finance Minister in the form of Nhlanhla Nene.
While the fiscal leadership has come full circle, the fiscal position remains dire. Yet the market reacted very positively to the 1ppt VAT hike and the potential for a reduction in bond issuance, as the MTBPS provided a very low base. The pace of consolidation slows after the first year, while debt stabilises 3ppt higher and only in year five. Even so, the combination of a new Eskom board, a VAT hike, a cabinet reshuffle (a strong trio of Nene on finances, Gordhan on SOEs, and Zweli Mkhezi on local governments) and upward GDP revisions should be enough for Moody’s to conclude its review on 23 March with a Baa3.
While South Africa has proven to be institutionally resilient, it does not guarantee policy certainty. Progress is expected on the State Capture enquiry, while the new mining minster, Gwede Mantashe, has committed to resolving the impasse on the mining charter within the next three months. The new concern lies with the passing of the motion to review Section 25 of the constitution which deals with expropriation. The demand for free land, follows the policy adoption of free health and free tertiary education. Hence, some cautions is still warranted.
Global markets are yet to recover from the risk-off in early-February, even as DM bond yields have consolidated and growth remains fairly robust. The new Fed Chair Powell sounded more hawkish than his predecessor, citing the much improved growth outlook, tailwinds, and monetary policy rules – for the most part these suggest that the Fed Funds rate should already be higher than the current 1.50%. Hence, the risk that the dots move upwards aggressively in the 21 March FOMC release.
From the SARB’s perspective, the improving domestic backdrop, in particular the view that Moody’s will not downgrade the rating, will probably outweigh the less certain global milieu, resulting in dissipating inflation risks. However, the MPC is unlikely to ignore a more hawkish Fed and would be concerned about the implications of a VAT hike for inflation expectations and wage demands. In this light it is not obvious that the SARB will be willing to cut at the March MPC meeting.
Bond market developments
SA outperformed its peers, with a 35bp rally in the 10-year yield, while the SA/US 10-year yield differential fell by a further 50bp, to 545bp, the lowest since early-2015. SA’s 5-year CDS has settled around 145bp after a temporary spike to 170bp on the delay of the SoNA. The credit premium is trading at levels last seen in early-2013, indicating that the market is not discounting further rating downgrades. The constructive stance on SA is borne out by the strong recovery in foreign bond purchases, which amounted to R17bn in February.
The theme of bond market outperformance continued: the ALBI gained 3.93% versus 2.05% for fixed-rate credit and 1.12% for ILBs, while cash returned 0.54%; floating-rate credit lost 2.67% during January, while property slumped by 9.9%.
While US yields will most likely remain elevated and may increase further, EM credit risk premia remain contained thanks to the strong global recovery and improved domestic fundamentals. With the US 10-year yield at 2.90%, SA sovereign spread of 210bp, and the SA/US inflation differential of 300bp, the underlying fair-value on the SA 10-year yield remains around 8.00%. At 8.30% SA nominal bonds still offer some value on a real return basis.