SARB prudence amid fiscal fears
Covid remains front and centre for global markets – whether it is the risk of renewed lockdowns or the opening of the world economy. While some Eurozone countries are experiencing a “second wave” of infections, the optimism on finding a viable vaccine has dominated. So too has the ongoing provision of monetary stimulus, as the Fed has turned more dovish by adopting average inflation targeting (AIT) as part of its framework. This has re-introduced upside inflation risk to the debate.
Higher inflation will erode the real value of debt, as long as it does not lead to meaningfully higher financing costs. This is not an imminent threat in the US, as quantitative easing and the dollar’s reserve currency status cap yields, for the time being. Moreover, recent inflation data from the Eurozone has highlighted the headwinds to higher inflation in developed markets from demographics and low energy prices.
Emerging markets are not quite so lucky. They do not have reserve currency status and often rely on foreign investors to fund their deficits. This means that they are unable to compete effectively in the “race to the bottom” in FX, as global capital will be reluctant to invest in an economy where the currency is perpetually vulnerable.
While the SARB has been criticised for not being more aggressive with regard to rate cuts, quantitative easing, and bailing out the government, it has arguably done more than many other spheres of government. Rather, the SARB has not allowed liquidity to skyrocket. SA’s money supply growth is currently around 10% y/y, less than half the pace reported for the US. To boot, the Bank has upped its sterilisation efforts to offset some of the earlier liquidity injections, the modest bond-buying programme, and the repatriation of the IMF and NDB loans. This independence and orthodoxy have anchored the rand of late and have kept the country’s sovereign credit rating afloat, even if this has fallen firmly into BB territory.
The faster reopening of the economy than the original risk-based proposal – with the move to Level 2 mid-August – reduces the imminent need for further rate cuts. While we think there is still some scope for monetary stimulus, the trade-off may be one of timing. To be sure, the fiscal position is firmly back in focus given the slump in tax receipts, most notably from corporates. In addition, SOEs have increased their demands on state coffers with SAPO, ACSA, and the SABC in need of financial aid.
The missing piece in solving the fiscal puzzle is the political will to implement reform. Granted, the government has implemented a nominal wage freeze in FY21, but this is being contested in the courts. Broader and deeper reform will require stronger leadership. In this regard, the month-end NEC meeting press conference was received with optimism. There was a firmer commitment to deal with graft within the party, while President Ramaphosa managed to quell the idea that certain factions within the ANC would be able to mobilise against him (at least at this juncture).
In confirming the implementation of the Nasrec conference resolutions, there will be renewed concern about the SARB’s independence, as well as radical economic transformation. This could entail disorderly land reform via expropriation without compensation (which, understandably, has gone rather quiet since last year’s elections), as well as prescribed assets.
The September MPC meeting and the October Medium Term Budget Policy Statement (MTBPS) will be two crucial markers for investors and the markets to gauge the policy evolution and reform progress.
Market developments
The performance during August was wide ranging. Inflation-linked bonds (3.9%) took pole position in August, followed by fixed-rate bonds (0.9%) and cash (0.4%). Equities (-0.3%) and listed property (-8.6%) underperformed cash.
Despite ongoing dollar weakness, low DM yields, and unprecedented stimulus, global risk sentiment varied during the lull of the northern hemisphere summer holidays. August delivered wide-ranging returns across and within asset classes as idiosyncratic factors came to the fore.
Falling real yields and the Fed’s adoption of AIT pushed the dollar index 1.3% weaker, to 92. The bulk of the gains were against the riskier G10 currencies, as the euro oscillated around 1.1825. EM FX was a mixed bag despite the weaker dollar and relatively robust commodity prices, which increased by between 5% and 10%. A striking exception was gold: after reaching a record high of $2070/oz, the yellow metal ended the month unchanged. Winning currencies largely reflected the weaker dollar, gaining between 1% and 2%, while the losses were more pronounced (such as -5.1% for the Turkish lira and -5.0% for the Brazilian real). The rand’s 0.8% gain belies a more challenging month as USD/ZAR reached almost 17.80 before closing the month sub-17.00. USD/ZAR is close to our fair-value range of 16.00 – 16.50. Ongoing dollar depreciation would be supportive of a stronger rand, but domestic growth woes and fiscal fears are potential headwinds.
After reaching a record low of 0.50%, the US 10-year yield rose by 20bp amid the weaker dollar, upside inflation surprise, rising oil price, and the shift by the Fed. In contrast to July, widening breakeven inflation was due to the rising nominal yield rather than the falling real yield. The latter moved broadly sideways around -1.0%. Breakeven inflation reached 1.8%, matching the January high, but this is still comfortably below the 2.2% reached in 2018. The absence of yield curve control has for now been countered by ongoing QE and a commitment to allow inflation to run above 2.0% for a prolonged period. The absolute level of DM yields should be supportive of capital flows to emerging markets, but conviction on the EM recovery is low. Hence, EM credit spreads have moved broadly sideways, while hard currency and local currency indices eked out only modest gains in August. EM yields were unchanged, on average, with the bulk of the countries moving within a ±20bp range. At the extremes, Lebanese yields rallied by 330bp to a still distressed 40%, while Pakistan’s yield rose by 100bp, to 9.87%. SA was in the middle of the pack with the R2030 muddling around 9.25%. Based on our fair-value analysis, the market is already discounting a debt/GDP ratio above 80% and screens moderately cheap with attractive implied real yields.
On balance, improving prospects of a Covid-19 vaccine, positive data surprises, and the steady normalisation in activity more than offset escalating geopolitical risks – US/Sino tensions surrounding TikTok and the lack of a Brexit deal. Notwithstanding all the headlines around tech stocks, a reasonably broad based rally pushed the S&P500 to a record high in August. While developed market posted a decent 6.7% return based on the MSCI World Index, emerging markets lagged with 2.2% with a wide-ranging underlying performance. The MSCI South Africa index lost 1.2% in dollar terms, while the ALSI and the SWIX declined by 0.3% and 1.0%, respectively. The pressure on the market stemmed largely from financials (-4.2%) where earnings revisions have remained negative and interim updates from the large banks pointing to a substantial lockdown hit. The other stragglers fixed line telecoms (-21.6%), media (-8.2%), gold (-5.7%), and health care (-2.4%). Consumer goods (3.7%) and industrials (2.0%) posted moderate gains as the economy moved to Lockdown Level 2 and the ban on cigarette and alcohol sales were lifted mid-month.
