Easy policy the upside of pessimism
For many, January felt like a particularly long month. Health care workers were pressured by resurgent Covid-19 cases and the confirmation of three new, more virulent variants of the coronavirus, in Brazil, the UK, and South Africa. Politicians had to ponder the severity of renewed lockdowns, continuing to balance lives versus livelihoods. And many working parents had to share the zoom rooms with their children as school openings were delayed.
Markets mostly tracked sideways in January as supportive factors, such as easy money and stimulus, were countered by the uneven vaccine rollout and the tiff between day traders and hedge funds. A reality check was probably in order. The vaccine rollout was always going to be uneven for various reasons, even if much of the good news was in the price. At best, developed countries were expected to achieve some semblance of herd immunity during 2H21, while many emerging countries would lag substantially. Herd immunity as a goal has been questioned, given the ability of the virus to mutate and the lack of evidence that vaccinations curb transmission. It would seem that Covid waves are very much about human behaviour – wearing masks and the size of gatherings. In this regard, complacency will very likely ensure that we face a renewed surge in cases in a few months’ time. South Africa managed to procure various vaccines, but vaccine efficacy (in the context of the new strain) and government’s ability to distribute the vaccines remain highly uncertain.
The Blue Sweep in the US has ensured that substantial fiscal stimulus is now much more likely, but so too the possibility of tax hikes. Concerns about substantial US Treasury issuance and the potential for the Fed to taper its asset purchases put upward pressure on US nominal yields. While fears of a taper tantrum are overdone, higher US yields might be a hurdle to EM performance later in the year. For now, emerging markets are benefiting from elevated commodity prices and current account rebalancing. This should support FX valuations, even if dollar depreciation slows. Yet higher commodity prices, notably in agricultural, could limit the ability of monetary policy to remain overly supportive. Many EM central banks have turned more cautious, with markets pricing in hikes for Brazil, Chile, India, and the Philippines.
Even in South Africa, the market is no longer discounting cuts as the MPC kept the repo rate on hold for a third consecutive meeting. Admittedly, it was another close vote, with two members favouring a cut. The bank’s forecasts improved slightly – stronger growth and inflation a tick higher – but risks are seen as evenly balanced. With some on the committee still in favour of more accommodation, it is difficult to outright dismiss the potential for another cut later in the year, but if the rebound gains momentum – buoyed by rising commodity prices and DM liquidity – then the SARB may start to feel pressure to remove some of the crisis related accommodation. Much will depend on the policy transmission mechanism into credit growth and imports. So far, there is little evidence that near record low interest rates are fuelling household debt and eroding the trade surplus. Hence, it would seem that the SARB will be on hold for the time being.
Importantly, structural fiscal risk remains a feature of SARB deliberations, and this is unlikely to change. Yet, a fillip for SA markets has been the government revenue data. The economic rebound and strong terms of trade have boosted tax receipts, but this should be seen relative to an overly conservative estimate presented in the supplementary budget and in the Medium Term Budget Policy Statement (MTBPS). By many estimates, the tax take could overshoot the official estimate by as much as R100bn. This would lead to an improvement in the deficit of around 2ppt of GDP and a marginally lower debt ratio. The question for the pending Budget is whether Treasury will recognise this fully, or whether conservatism will be an ongoing feature. A concern for markets should be whether this “newly discovered” revenue could lead to additional demands for grant extensions – we have already seen the extension of the special Covid relief grant by another three months – and whether it complicates the upcoming civil service wage negotiations. On balance there seems to be an incentive for ongoing conservatism.
Market developments
SA equities (5.2%) were off to a solid start in 2021, outperforming the other major local asset classes. Inflation-linked bonds (2.0%) beat fixed-rate bonds (0.7%) amid rallying commodity prices and nascent inflation concerns, while property (-3.2%) underperformed cash (0.3%). The moderate depreciation in the rand (-3.2%) versus the US dollar would have been accretive to offshore and dollar commodity exposure.
After reaching a three-year low in early January, the dollar index (DXY) posted a modest recovery, aided by taper talk, higher US yields, and periods of risk off. Even so, FX volatility remained relatively subdued during the month. US Treasury Secretary Yellen backed a market-determined exchange rate, which probably lent further support to the greenback. The 0.7% appreciation in the DXY was a headwind to EM FX, which buckled under renewed risk discrimination and lockdowns. The rand lost 3.2% during the month, keeping company with the Brazilian real and Colombian peso. Nevertheless, USD/ZAR between 14.50 and 15.00 is still modestly overvalued compared to our 15.50 – 16.50 fair-value range, which is based on a combination of financial market inputs (such as VIX), cyclical factors (such as commodity prices), and fundamentals (such as productivity growth).
The Georgian election results, attendant Blue Sweep, and taper talk lifted the US 10-year yield to 1.15% amid expectations of large fiscal stimulus and rising funding requirement. Even so, the 10-year TIPS yield remained below -1.0% for most of the month, mitigating some of the headwinds to emerging market bonds. The EMBI lost 1.1% in January, while the GBI-EM declined by 1.5%, despite renewed portfolio flows into EM. EM credit default swap spreads and bond yields widened during January, but South Africa was a relative outperformer with the 10-year yield unchanged month-on-month. The market remains fairly valued based on our metrics, but improving risk appetite, a positive narrative around SA Inc. and the rebound, and the government finance data, have priced out much of the excess risk premium in bonds. According to JSE data, non-residents bought net R8.3bn worth of government bonds in January, but the official holdings statistics shows that it was more than double, at R19.3bn. An important consideration for the curve will be whether Treasury lowers the weekly auction sizes. This announcement may not be explicit in the Budget, but there is scope for a modest reduction from April.
Easy monetary policy, pending fiscal expansion, and the vaccine rollout compensated for lockdowns in January, lending support to already elevated developed equity markets. However, the VIX spiked towards the end of the month as surging retail trading activity triggered short squeezes in selected US stocks. A broader, but temporary risk-off ensued, leaving most major markets down for the month. The MSCI World Index lost 1.0% in January, but the MSCI Emerging Markets Index gained 3.1%, largely thanks to the Chinese market amid ongoing CNY appreciation. Despite the weaker rand, the MSCI South Africa Index rose by 2.7% in dollar terms, making it a relative outperformer among EMs. Non-residents bought net R3bn of SA equities in January, following a robust R15.3bn in net inflows in December. The SWIX gained 5.0% with health care (10.8%) and technology (14.5%) the relative outperformers. Basic materials (5.0%), consumer goods (4.7%), and industrials (4.2%) were broadly in line with the overall performance, while telcos (2.7%), consumer services (2.0%), and financials (-2.6%) were the laggards. Earnings revisions have been positive in recent months, as the worst of the lockdown hit entered the base. Yet, the rating remains depressed relative to history and EM peers, as the market continues to discount a sustained weak macro backdrop.
