Being less negative
We know that two wrongs do not make a right, except mathematically, when we get a positive number by multiplying two negative numbers. Yet, it would seem that in the case of SA, a less negative negative could be a positive.
Terms of trade, inventories TO support 2021 growth
In particular, the smaller revenue shortfall recorded in FY21 has altered the cyclical fiscal outlook for the better and resulted in lower weekly bond auction sizes. While analysts and the media referred to a revenue overrun, there was still a shortfall of R160bn in main budget revenue compared to the February 2020 budget. Admittedly, this was less negative than the R300bn shortfall that was expected in the June 2020 supplementary budget. While it does not solve the long-term fiscal problems, it does provide a short-term buffer for the debt ratio and the credit rating. An unintended consequence is that public sector unions may now think there is spare cash for a nice fat wage increase, but this “spare cash” will be used to partly fund the FY22 budget deficit, which is expected to be around 8%/GDP.
The strong terms of trade have not only boosted revenues, but have lifted nominal GDP growth. As a result, the debt-to-GDP ratio should rise by less than previously estimated, at least in the shorter-term. At a real level, base effects are the dominant force driving the expansion, but the inventory cycle could also be a key determinant of the GDP growth in 2021. The pandemic-driven lockdown resulted in a substantial inventory drawdown of 3.1% of GDP, the worst on record since 1960. Because GDP is a flow and not a stock, even if there is another inventory drawdown in 2021, as long as it is less negative than last year’s decline, it will positively contribute to GDP growth.
Too much good news could lead to tightening
During a recession, lots of bad news is good news, because it means policy makers will ease aggressively. In the early part of the recovery, this still holds, as bad news usually ensures that policy makers stay accommodative. However, there is a risk that we are moving into the phase when too much good news becomes bad news by way of bringing forward the exit from crisis level policy, in particular by the Fed. This is what the market fretted about in February and March, but the dovish FOMC has temporarily placated the market on taper talk and inflation fears.
There is still significant uncertainty about the longer-term inflation outlook. Many secular factors support the inflationist view, but there are just as many that favour a deflationist stance. From a cyclical perspective, the intersection of supply and demand determines the price. Currently, a positive demand shock – reopening – is meeting a negative supply shock – supply disruptions. The reopening of developed economies has stoked trade activity at a time when supply chains remain disrupted by serial lockdowns, as well as idiosyncratic factors in various commodity prices, for example, the flooding at two of Norilsk’s Russian mines. In addition, generous stimulus cheques and unemployment insurance in the US could be keeping people out of the labour market.
There are various positives and negatives to consider for the economic and market outlook. On balance, domestic factors have turned more positive, which partly explains the rand’s resilience. The terms of trade boost is also a boon, but early taper talk and upside inflation risk are the major negatives to be aware of in the coming months.
Listed property (11.7%) surged ahead in April, outpacing the other asset classes by a substantial margin. Fixed-rate bonds (1.9%), inflation-linked bonds (1.1%), and equities (1.0%) posted pedestrian gains, but still managed to beat cash (0.3%). The 1.9% appreciation in the rand was modestly dilutive for offshore asset returns.
Rand resilience aided by dollar weakness
Following the surprise rebound in March, the dollar index lost 2.1%, reversing almost all of the Q1 gains. The decline in US real yields weighed on the dollar, while the ongoing trade rebound and improving risk appetite added to the pressure. EM FX did not fully benefit from the weaker dollar, with the average appreciation only 1.2%. The slow vaccine rollout in the emerging world could have been a factor, alongside country-specific risk aversion, such as in India (surging Covid-19 infections), Peru (leftist politics), Colombia (fiscal strain), and Turkey (politics and lockdown).
While the rand gained 1.8% against the greenback, outperforming many of its high-yielding peers, lower US rates allowed low-yielding FX to outperform, with the Polish zloty (up 4.0%) taking pole position. The Brazilian real (up 3.6%) staged a recovery in April, but is still 1.5% weaker year-to-date compared to the 2.9% gain in the rand. USD/ZAR traded as low as 14.16, boosted by commodity prices, while relatively high funding spreads, a record trade surplus, improving cyclical fiscal position, and receding political risk contributed to the rally. At 14.25, USD/ZAR was around 8% overvalued based at month-end.
US yields retreat, but EM still a mixed bag
US yields decline moderately in April, easing concerns about tightening financial conditions. The 10-year yield fell by 11bp, while the 10-year TIPS yield declined by 14bp. As a result, breakeven inflation widened further, to an 8-year high of 2.4%. This level is within prior cyclical peaks and is not signalling that the Fed is about to lose control of inflation. Importantly, the term premium receded, which may reflect lessening fears about the funding need.
While the bias is still for higher US yields, the recent stability has boded well for risk appetite. EM bonds benefited, with the EMBI gaining 2.2% and the GBI-EM index up by 3.1%. The underlying local market performance was a mixed bag. On average, EM yields were down by only 3bp, with Turkey rallying by 53bp, while Peru sold off by 43bp. SA’s 10-year yield declined by 20bp in April, supported by global and local dynamics. The market is screening cheap based on our fair-value models, particularly in light of the significant cumulative decline in the weekly auction sizes.
S&P at record high, SA lags
Equity markets were generally buoyant in April amid improving risk appetite, strong macro data, and surging earnings growth, with the S&P500 reaching a record high. Lower US bond yields countered concerns about higher taxes to fund the US fiscal packages. Developed markets outperformed emerging markets based on the MSCI World Index total return of 4.7% versus 2.5% on the MSCI Emerging Market Index. Even so, the latter was a reversal from April’s loss. The MSCI South Africa was a relative laggard, losing 0.2%, but this came off a strong 6.1% gain in March.
The ALSI gained 1.0%, while the SWIX slipped by 0.3%. Healthcare (7.5%), consumer services (3.7%), industrials (3.0%), and basic materials (3.0%) outperformed, with chemicals (13.6%) and travel and leisure (7.0%) benefiting from the rebound in the oil price and the reopening, respectively. Telecoms (1.8%) and financials (1.5%) posted more muted returns, while consumer goods (-1.9%) was weighed down by food producers (-3.1%) and technology (-6.0%), which reflected the sell-off in Prosus and Naspers.