A solid last dash for 2021
December saw renewed impetus behind the hawkish shift in global monetary policy as Omicron fears receded and inflation pressures persisted. Yet risk assets were, for the most part, unperturbed by the repricing in interest rate expectations as global equity markets ended the year on a strong note. Even escalating geopolitical tensions – notably the threat of Russia invading Ukraine because of demands over NATO and the US-Sino tit-for-tat sanctions – did not dent investor optimism in the final month of 2021.
March FOMC meeting is “live”
The Fed’s dot plot lifted from projecting one hike to three hikes for 2022, with the Fed funds futures curve pricing in a full hike for April. The analysts’ consensus forecast has also pulled the timing of the first hike into 1H22, whereas only a few months ago many dismissed the idea of lift-off in 2022.
The BOE delivered a surprise hike in December, while central banks in Norway, Czech Republic, Poland, Russia, Mexico, Brazil, Chile, Peru, and Colombia continued their hiking cycles. In contrast, China eased, albeit very modestly, with a 50bp RRR cut.
Omicron not as menacing as feared
The spread of the Omicron variant caused short-lived anxiety (although the more recent surge in the developed world could have growth consequences), as policy makers looked through any short-term impact. Rather, the focus remained squarely on inflation risks. Whereas some travel restrictions were retained over year-end, global activity continued to recover. This also held for South Africa, which was in the eye of the Omicron storm in 4Q21.
The fourth wave was very sharp, but surprisingly short, prompting the government to ease rather than tighten restrictions. This brought welcome relief in light of weak consumer confidence and the larger-than-expected contraction in the economy in Q3.
A mixed bag of SA data
Improving mobility and robust commodity prices, notwithstanding notable volatility, have supported tax revenue receipts. Based on the provisional financing figures, corporate income tax take was strong in December. An estimated R45bn monthly budget surplus would be above the seasonal (pre-Covid) trend. As such, the fiscal position has some buffers to deal with short-term growth and spending pressures.
While Q3 growth disappointed, with the 1.5% decline largely due to the Delta wave and social unrest, the current account remained comfortably in surplus, at 3.6% of GDP in Q3, and inflation was relatively well behaved at 5.5% in November. Encouragingly, food price inflation moderated somewhat, but this was countered by the surge in fuel price inflation.
The petrol price reached a record R20.29/litre in December, giving much fodder to many a memer. While modest reprieve of a 68c cut was announced for January, the renewed ascent in the oil price will maintain focus on fuel price policy, as well upside inflation risks and the pace of SARB rate hikes.
Market developments
During December, listed property (7.9%) outperformed the other asset classes, while equities (4.8%) and inflation-linked bonds (4.5%) posted solid results. Fixed-rate bonds (2.7%) outperformed the modest return on cash (0.4%). The rand was flat against the dollar (0.2%) in December, which would have been neutral for offshore returns.
Equities (15.1%) surged ahead in 4Q21, followed by solid gains on listed property (8.4%). Inflation-linked bonds (5.1%) and fixed-rate bonds (2.9%) comfortably beat cash (1.0%) during the quarter. The rand lost 5.2% against the greenback, which would have enhanced offshore returns.
Listed property (36.9%) pipped equities (29.2%) to take pole position in 2021, while inflation-linked bonds (15.5%) posted almost double the return on fixed-rate bonds (8.4%). Cash (3.8%) fell short of inflation, while the 8.0% decline in the rand would have boosted offshore returns.
Disparate FX returns amid easing risk aversion
Volatility in the FX market eased during December, with most currency pairs trading in a relatively narrow range. There were no obvious broad-based themes during the month, with country-specific factors dominating amid an improvement in risk appetite. The dollar index (DXY) lost 0.3%, despite the more hawkish Fed dot plot and accelerated taper. The risk-on backdrop was reflected in a weaker Japanese yen and stronger G10 currencies, such as the Australian dollar, the New Zealand dollar, and the Norwegian krone.
EM FX gained 0.4%, on average, against the greenback, but this belies disparate underlying movements. On balance, where EMs hiked rates, FX gained – notably the Mexican peso (4.4%), Czech Koruna (3.0%), and the Polish zloty (2.0%). For some currencies, such as the Colombian peso (-2.9%) and the Chilean peso (-2.7%), commodity price volatility offset the benefit of higher nominal interest rates.
The Turkish lira was very much in the spotlight in December, with USD/TRY spiking to 18.36 by mid-month only to collapse all the way down to 10.25. The net gain on the lira was 1.1%, as another pro-cyclical interest rate cut was followed by the announcement of special measures to shore up domestic savings and encourage the return of resident capital.
The rand traded broadly sideways against the US dollar, gaining a mere 0.2%, as the benefit of the post-Omicron commodity price rebound was dampened by the resilient dollar. At 15.60, USD/ZAR is trading cheap versus our 14.50 – 15.50 fair-value range.
A delayed reaction to a more hawkish Fed
Concerns about the Omicron variant and the negative implications for growth capped developed market bond yields during early-December. However, the rebound in commodity prices, reversal of mobility restrictions, and the more hawkish Fed pushed yields and breakeven inflation higher towards the end of the month. The US 10-year yield rose by a mere 6bp, to 1.51% in December, while the 2-year yield jumped by 18bp as the market priced in a more aggressive hiking cycle.
Similar to the FX market, the EM local bond market performance was rather mixed. The Turkish 10-year yield surged by 300bp as inflation hit a 19-year high of 36%. Outside of the Anatolian extremes, the EM performance ranged from a 56bp sell-off in Poland (rising inflation and rate hikes) to a 46bp rally in Russia (stabilising inflation and rebounding oil price).
South Africa was a relative outperformer, with the 10-year yield falling by 43bp to 9.80%. Despite the recovery, inflation-linked bond yields rallied more sharply, resulting in break-even inflation remaining above 5.5%. This points to a substantial risk premium in nominal bonds, with the 10-year yield trading cheap versus our 9.00% – 9.50% fair-value range. The combination of inflation fears – the higher oil price, weaker rand, and global price pressures – and fiscal risks – associated with populist spending pressures – stemmed the decline in yields.
The Treasury’s bond holdings data shows that the share of non-resident holdings stabilised at 28.2% in December, which equates to a 1.8ppt drop over the calendar year. Non-residents bought a net R5.9bn in December, accounting for almost a third of net issuance. For the full year, net foreign inflows totalled R32.3bn, which amounts to only 12% of net issuance. The bulk of the issuance in 2021 was taken up by domestic unit trusts (43%) and official pension funds (23%).
Equity markets shake off the risks
Despite the double whammy of Omicron and a hawkish Fed, the major equity markets staged a solid recovery in December after a lacklustre November. The S&P500 gained 4.4%, while the Eurostoxx and FTSE were up by 4.9% and 4.5%, respectively. Thanks to sustained policy support, the S&P500 delivered a total return of almost 30% in 2021. While many local bourses delivered total returns in excess of 20% – including South Africa (29.3%) – FX weakness more than offset these solid gains leaving the MSCI EM Index down by 2.4% for the year compared to the 21.8% gain on the MSCI World Index (both in dollar terms).
Developed markets (4.3%) outperformed emerging markets (1.9%) in December, as FX weakness detracted from returns. Chile was a notable laggard (-8.8%), while Mexico (13.1%) and Czech Republic (13.1%) outperformed. The MSCI South Africa Index (4.3%) outperformed the EM average. The ALSI and SWIX gained 4.8% and 4.6% respectively.
All of the major sectors ended the month in the black, with financials (8.6%) taking the lead amid falling long-term yields and positive earnings revisions. Consumer staples (6.5%), industrials (5.5%), and basic materials (5.4%) outperformed the market, while telcos (4.5%) were in line. Laggards were contained to consumer discretionary (2.1%), technology (0.8%), and health care (0.4%).
The strong end to 2021 has driven a further re-rating to almost 11x on a forward PE basis. However, this is still a near 25% discount versus the long-run average. While negative earnings revisions have broadened in recent months, the bulk of the cheapness still stems from the resources sector, where the commodity price rebound is seen as temporary (while policy uncertainty persists).
