The rebound in asset prices that ensued following the US elections in November boosted South Africa’s terms of trade, ensuring another sequential current account surplus (of 5.0%/GDP) in the first quarter. The positive spillovers were also seen in upgrades to 2021 GDP growth forecasts, and rand appreciation. To be sure, USD/ZAR traded below 14.00 for the past month, which, in turn, triggered forecast revisions amongst the analyst community for an even stronger rand.
Yet, the reflation trade has not been smooth sailing. The increase in US Treasury issuance at the start of the year, nascent inflation fears, and the adoption of flexible average inflation targeting (FAIT) by the Fed caused a doubling in the UST 10-year yield and a near doubling in the US 10-year TIPS yield over the course of February alone. EM bond markets and currencies weakened as portfolio flows reversed. However, the Fed quickly talked back the market’s concerns over the tapering of asset purchases. This, combined with the drawdown in the US government’s cash balances ensured that EM assets could again ride the wave of ample US dollar liquidity. The calmer policy waters during April and May allowed EM asset prices to recover as US Treasury yields declined, despite serial and substantial upside surprises to US CPI inflation.
More recently, the extent of the inflation acceleration and broadening price pressures evident in commodities, input costs, and at the factory gate have caused the Fed to change tack. The hawkish interpretation of the June FOMC meeting, particularly the increase in the 2023 median dot, has caused some turbulence in markets, with EM bond yields higher and EM FX weaker. USD/ZAR is back above 14.00.
To compound matters, we now have to navigate the third wave of Covid-19 infections locally. While the level 3 lockdown is not yet punitive to the growth outlook, there is much debate about the duration of the third wave and the potential for greater restrictions. Luckily, we still have our sea legs and instead of hunkering down in the harbour, we continue to scour the market seas for opportunities.
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