Taking on the wage bill
SOSO (stimulus on/stimulus off) exacerbated RORO (risk on/risk off) in October. Covid-19 and vaccine developments remain the underlying drivers of markets (as POTUS and FLOTUS both tested positive for Covid-19), but there was a growing acceptance that a “blue wave” may not be that bad for the equity market after all. The pressure on the Fed to keep things easy mounted, as there was notable uncertainty about the size and timing of additional fiscal stimulus, even with rising odds of a united Democratic government. In addition, the pace of the recovery has started to slow, which has contributed to a more cautious outlook.
South Africa moved to Lockdown Level 1 in October, including the selective allowance for international travel. High-frequency mobility and transactional data show an ongoing improvement in domestic activity, while Stat SA’s supply-side data point to a 40%+ GDP expansion in Q3 (annualised, of course). The trade balance could print a 9%/GDP surplus in Q3, which would propel the current account to a 4%/GDP surplus, which would be the largest since 1988.
Despite the upside risk to GDP growth and fiscal revenues from robust terms of trade, the Treasury turned more conservative in its macro and revenue expectations in the October Medium Term Budget Policy Statement (MTBPS). Growth was revised downwards for 2020, while the medium-term deficit profile is wider than in the June budget because of a slower pace of consolidation. Yet the market impact of the fiscal slippage was countered by the strategy to take on the wage bill in a bid to protect service delivery and capex programmes. The private sector labour market has been weakened by the lockdown, arguably putting labour unions on the back foot. This makes it an opportune time for the government to take a stronger stance against the labour unions.
The debt ratio is projected to peak at 95% compared to 88% previously, as the MTBPS had to incorporate the President’s Economic Reconstruction and Recovery Plan (ERRP), as well as the persistent ideological support for SOEs. To be sure, SAA received the initial R10.5bn it requires to implement its business rescue plan, but this has forced spending cuts elsewhere. The ERRP was a wish list of government interventions, focussing on infrastructure, energy security, localisation, and employment. While it aims to crowd in the private sector, there is a risk that too much of the execution still sits within the state, that localisation will add to the regulatory burden on SMMEs, and that there are no strict timelines along which to measure the success of the various projects.
The positive aspect is that should government succeed in improving energy provision and start spending tax revenues more effectively, the fiscal multiplier may turn positive again. As the SARB’s Monetary Policy Review (MPR) noted, the fiscal multiplier has steadily declined and some estimates indicate that may even be negative. A more effective government could boost confidence and growth, which should reduce the fiscal risk premium and lower economy-wide funding costs. Yet in the short term, the trade-off for the SARB remains a lack of reform and the attendant fiscal cliff, versus the potential fiscal tightening that will ensue should the government follow through on the promised spending cuts. The bias is still towards low for long or even lower rates. As such, a November rate cut should not be ruled out entirely.
Market developments
Inflation-linked bonds (1.1%) and fixed-rate bonds (0.9%) beat cash (0.3%) in October, while equities (-4.7%) and property (-8.5%) underperformed sharply.
The dollar gained 0.2% m/m, but the rise belies intra-month weakness, as the DXY index spent the bulk of the time below the opening level. Uncertainty regarding fiscal stimulus and the US elections weighed on the greenback, as markets digested the prospect of a “blue wave” outcome. EM FX was wide ranging, from a 4.1% gained for the Mexican peso to a 7.7% loss for the Turkish lira. The rand was a relative outperformer, up 2.7% for the month. USD/ZAR ended the month at 16.25, in the middle of our tactical 16.00 – 16.50 fair-value range.
US yields rose modestly during October, driven by rising odds of a “blue wave” and substantial spending-led fiscal stimulus. The bulk of the move was via wider breakeven inflation alongside the weaker US dollar, even as underlying inflation continues to fall short of expectations. EM external debt was flat for the month, while local markets rose only 0.4%. EM yields declined by 15bp, on average, with SA in line with the median drop of 12bp. The local curve sold off in the wake of the MTBPS, with the 10-year yield closing the month at 9.30%, which is moderately cheap versus the inflation outlook and the peer group.
Global equity markets varied sharply in October as EMs benefited from increasing mobility and dollar weakness, while DMs struggled against the second wave of Covid infections and US election uncertainty. The MSCI World Index lost 3.1% (total return) versus a 2.1% gain for the MSCI EM index. The MSCI South Africa Index eked out 0.5% in dollar terms, while the ALSI and SWIX lost 4.7% and 2.4%, respectively, in rand terms. The pressure stemmed from basic materials (-10.9%, on the back of lower commodity prices and a stronger rand), as well as consumer goods (-9.3%), health care (-6.3%), financials (-5.8%), and industrials (-3.2%). Positive performance was limited to technology (6.7%, Naspers and Prosus), as well as telecoms (1.2%, mobile gains countered fixed line losses).
