Monetary policy and statistical magic
Uncertainty remains pervasive, whether it relates to the duration of “transitory” inflation in the US and now the Eurozone, the size and timing of US fiscal stimulus, the recovery in the US jobs market, the impact of regulatory tightening in China, or the end of Covid. To be sure, August was a more challenging month on the macro front, yet the S&P 500 reached a record high. We must remind ourselves that financial markets are not the real economy, and that equities can easily look through short-term bumps in the road.
Cyclical slowdown underway
On this score, the global economy has lost momentum and we have more clearly entered a cyclical slowdown. Markets are seemingly comforted by this, as it would mean renewed stimulus (where there is space, such as in China) or at least ongoing accommodative monetary policy (as suggested by Powell at Jackson Hole).
The global PMI has moved from acceleration to moderation, with more countries posting PMI declines than increases in August. South Africa was an exception, as the PMI recovered sharply off the looting-induced low base in July. Liquidity indicators have also rolled over more clearly, with central bank balance sheet growth easing further alongside notably lower money supply growth and negative credit impulses across many of the large economies.
Commodity prices signal slower growth expectations, but this may partly reflect the impact of the Delta variant and associated lockdowns, as well as the gyrations in the dollar. Even so, following serial upgrades to growth forecasts, consensus numbers have now been marked lower for the US and China, reflecting the trend of negative data surprises.
But taper to commence this year
Jackson Hole gave confirmation that the much-feared Fed taper will commence this year, which means within the next four months, barring a large negative shock. The key metric to watch seems to be the progress on US job creation, but this is being challenged by Delta, benefits, and potential sectoral mismatches.
The debate on inflation continues, with some of the Covid-related items showing moderating inflation rates. The strong US housing market and the end of the moratorium on evictions could give rise to stronger rental inflation. Shortages continue to impact on supply-chains and input prices, even if the peak of commodity price inflation is probably in the base.
So far, consumer inflation expectations have risen only moderately, but elevated inflation poses downside risk to real consumption demand, particularly owing to the fact that unemployment benefits and stimulus cheques are running out. This, alongside fears of the Delta variant, has already dampened consumer confidence in the US.
Rand resilience continues to surprise
A feather in the SARB’s cap is that SA inflation – both headline and core – is now running below that of the US. The last time this occurred was in 2006, just before the oil price took off and the rand started to weaken amid an unsustainable current account deficit.
How things have changed. The rand is benefiting from elevated commodity prices, notwithstanding recent declines, a current and trade account surplus, high FX funding costs, and high long-term real yields. Inflation differentials moving in the rand’s favour may improve sentiment towards the currency, but inflation differentials matter in the longer run.
A further boost to the rand, and all other currencies, came from the IMF’s US$650bn allocation of Special Drawing Rights (SDRs). SA received the equivalent of US$4.16bn in SDRs to add to reserves, while also incurring the equivalent liability with the IMF. While there is still some uncertainty over the ultimate use of this “free IMF money”, the reserves data reflected them as part of the SARB’s gross reserves and not in the Treasury’s deposits. Even so, the government can use them to redeem external debt, with official comments suggesting an allocation to the IMF Covid loan.
But finding more historical GDP does not solve our fundamental problems
Another fillip was that the economy is now around 11% bigger than previously thought. After various delays, Stats SA published the revised GDP data that included the rebasing, re-benchmarking, and methodological improvements, which are done every five years. This time, the exercise added almost R550bn to nominal GDP via improved measurement of the finance, real estate, and business services, and the community, social and personal services components, as well as household consumption expenditure.
Encouragingly, GDP per capita rose from R73k to R80k, but you would be forgiven for not necessarily feeling richer. Granted, the fiscal metrics improve sharply due to the larger denominator, which retrospectively could lead to a better implied-rating level, but this may not be enough to turn the ratings tide after the Covid hit and social unrest.
Waving a statistical wand does not create jobs or additional tax revenue.
Expecting too much from central banks
Yet markets, politicians, and the electorate expect a lot of magic from monetary authorities as central banks face ever-expanding implicit mandates. The Fed already has a dual mandate of inflation and employment, while it has long been speculated that the primary objective is to ensure equity prices do not fall. Yet this has given rise to the blame game for inequality, which is a new potential target if one goes by by the Jackson Hole Symposium theme of unevenness. We can add financial repression to the Fed’s list of objectives, given that the sustainability of debt is largely determine by “r-g”, i.e. how real borrowing costs compare to real GDP growth.
If the Fed does expand its implicit mandate, it is likely to mean only a modest hiking cycle, if at all. If this is indeed the case, then there seems to be little exogenous pressure for the SARB to lift rates any time soon. We already know that the endogenous impetus to rate hikes remains absent – inflation and inflation expectations have been well behaved, the output gap is still large and negative, the employment gap is colossal, and there are no signs of financial excesses in the economy.
Unfortunately, the SARB is a price taker on some aspects of the policy inputs, even if it has worked inflation-targeting magic in recent years. Moreover, policy makers are supposedly forward-looking and may be reluctant to run negative real rates for too long. As such, we cannot dismiss the idea that the SARB may start repo rate normalisation before the end of the year, but the debate on what constitutes “normal” will continue.
Market developments
During August, listed property (7.5%) outperformed the pedestrian gains in the other asset classes. While fixed-rate bonds (1.7%) and inflation-linked bonds (1.2%) managed to beat cash (0.3%), equities (-1.7%) fell short. The 0.7% appreciation in the rand would have been marginally dilutive to offshore asset returns.
Dollar gyrates on taper talk
The dollar gained a modest 0.5% in August, with front-loaded appreciation driven by a robust July non-farm payrolls report, risk aversion from the Delta variant and regulatory tightening in China, and taper talk in the FOMC Minutes. Powell’s comments at Jackson Hole were adequately dovish to walk back some of the strength towards the end of the month.
This allowed EM FX to recover, with an average gain of 0.5%. The underlying performance was disparate, ranging from the 2.3% appreciation in the Hungarian forint to the 2.0% loss in the Chilean peso. The rand posted a middling 0.7% return, but the intra-month range of 14.32 to 15.30 on USD/ZAR reflected lower commodity prices and risk aversion. The rand’s recovery has taken USD/ZAR back into marginal overvalued territory based on our 14.50 – 15.00 fair-value range.
But bond market unperturbed
Bond yield movements were relatively subdued in August, with the US 10-year yield rising by 9bp, to 1.31%, and the yield curve (10s versus 5s) broadly stable. The TIPS curve bear-flattened modestly (-5bp), leaving breakeven inflation marginally lower (-6bp). Even so, at 2.3% – 2.5%, breakeven inflation is pricing in a moderate overshoot of the 2.0% target, in keeping with the flexible average inflation-targeting framework.
Confirmation of taper talk in the FOMC minutes and at Jackson Hole had minimal impact on the market, suggesting that the slowdown in QE is in the price. The Fed funds futures curve is discounting the first rate hike in January 2023, which is slightly more hawkish than the dot plot.
The average move in EM bond yields was marginally upwards in August, but the range was wide, similar to the FX performance. Brazil’s 10-year yield sold off by 96bp, while Turkey rallied by 35bp. Brazil’s sharp underperformance stems from rising inflation (9.0% y/y in July), hawkish central bank rhetoric, and fiscal risks.
SA was a relative, albeit modest outperformer, with the 10-year yield declining by 8bp, to 9.10%. The decline was muted in the context of lower inflation (4.6% in July), dovish MPC rhetoric, and the improved fiscal metrics following the substantial upward GDP revision. Despite the reduction in issuance in 1H21 and steady non-resident buying, the net supply is still ample enough to keep bonds trading at a slight discount versus our 8.50% – 9.00% fair-value range.
Monetary policy rhetoric lifts global equities
Equity markets had to contend with taper talk, lower commodity prices, and the fall-out from ongoing regulatory tightening in China. Yet dovish monetary policy rhetoric won the day, leaving the S&P 500 2.9% higher and the Eurostoxx 2.6% stronger.
The MSCI World Index gained 2.5% in August, matching the 2.6% return on the MSCI Emerging Market Index, which was dragged down by the MSCI China Index. The underlying country performance showed a stronger bias. Asian bourses, such as Thailand (11.5%), Philippines (11.3%), and India (10.9%) recovered after the July hit, while commodity-sensitive markets, such as Brazil (-2.3%), Canada (0.2%), and Australia (1.4%) were relative laggards.
The MSCI South Africa Index gained only 0.7% as the stronger rand countered underlying equity weakness. The ALSI lost 1.7% due to the 12% decline in Naspers, while the SWIX eked out a 0.4% gain as SA Inc. counters offset the losses on Naspers and resources.
The ALSI de-rated further in August, to a mere 9 times, leaving the market at a 30% discount to long-term valuations. Part of the de-rating resulted from another modest upgrade to earnings as domestically-oriented counters face improving earnings, alongside the recovery in the oil price. At an industry level, telco’s (16.4%), financials (11.4%), healthcare (8.3%), and consumer staples (4.4%) outperformed, while industrials (0.9%), basic materials (-5.0%), consumer discretionary (-9.8%), and technology (-12.2%) underperformed.
