South Africa continued to enjoy the tailwinds of the leadership transition as Moody’s not only affirmed the sovereign credit rating at an investment grade credit rating of Baa3, but moved the outlook from negative to stable. This allowed the SARB to cut rates by 25bp from 6.75% to 6.5%, despite the trough in inflation and ongoing US policy normalisation.
However, the positive domestic news flow was countered by negative global developments. In particular, “Bad Trump” has returned in full force with the imposition of numerous trade tariffs. The threat of escalating trade wars has weighed on global equity markets. Yet this percolating “risk-off” equities backdrop has not fully filtered through to all emerging markets (EM) assets as a result forex (FX) has moved sideways and bond yields have declined.
The removal of ratings risk and fall in inflation from 4.4% to 4.0% in February gave four of the seven Monetary Policy Committee (MPC) members enough comfort to cut the repo rate to 6.5%. While in line with the consensus expectation, it was a close call, suggesting limited agreement on the MPC regarding the appropriate level of the neutral real policy rate and the need for further easing. Given the reaction function over the past 12 months, it seems that recent inflation data, the balance of risks, the exchange rate, and an effective long-term target of 5.5% inflation will determine monetary policy moves from here. Hence, we cannot rule out further easing, but note that the hurdle for cuts is high given how close the March MPC outcome was.
With regard to the economy, the sentiment boost is yet to translate into meaningfully higher real activity. While quarter four (4Q17) GDP growth printed at 3.1%, high-frequency indicators for 1Q18 point to a moderation in sequential GDP momentum. The Purchasing Managers Index (PMI) retreated to 46.9 index levels in March after a brief spurt to 50.8 in February, which an index level below 50 indicating a contraction. The BER Business Confidence Index rebounded to 45, which is in line with the long-run average, but the underlying components remain mixed. The passing of the motion to review Section 25 of the Constitution to enable land expropriation without compensation has reintroduced policy uncertainty, which could again hinder fixed investment.
The consumer has found support from a recovery in real wage gains, but this will be partly offset by the VAT rate increase. Moreover, subdued employment growth and rising inflation require a stronger credit impulse to support household consumption growth. Yet household credit growth has become less sensitive to interest rates thanks to tighter credit criteria and the ongoing impact of stricter banking sector regulations.
The rand has treaded water in large part due to the stabilisation in the dollar. While the consensus has become more optimistic on further rand gains, the underlying macros may become less supportive. Rising inflation, lower real rate differentials, and a turn in the terms of trade could limit further appreciation. To be sure, it seems that the best of the current account news is in the base and an overvalued rand may start to erode SA’s export competitiveness.
The big question is the direction of the dollar. The short-term drivers – growth differentials, yield differentials and monetary policy expectations – have turned more supportive of the greenback. The greatest uncertainty is whether escalating trade tensions are bullish or bearish for the dollar. Moderating global trade growth – as indicated by the fall in the global PMI– would go hand in hand with lower global liquidity and stronger dollar. On the flip side, lower export proceeds would mean lower demand for dollar assets. On balance, the dollar valuation is not stretched and the risk bias points to EM FX weakness if trade wars ensue.
Bond market developments
SA performed broadly in line with the peer group as the 10-year yield rallied 15bp in March. Yet the performance was muted given benign fundamentals such as low inflation, a large reduction in government issuance, and a SARB rate cut. The SA/US 10-year yield differential has stabilised around 540bp, suggesting that the excess SA risk premium is now fully removed in the wake of Moody’s decision. Lower developed markets (DM) yields should be supportive of the SA market, but it may signal concern about global growth and demand for safe haven assets. SA’s 5-year CDS has settled around 150bp, which is a similar trend seen in late-2012. Foreign bond purchases were again robust in March, totalling R13bn. However, foreign investors are overweight SA, making the market vulnerable to risk aversion. With the macros less supportive of local fixed income, substantial foreign inflows are required to push the marker meaningfully stronger.
The ALBI gained 2.0% in March versus 1.0% for credit and 0.56% for cash. ILBs returned 4.3%, outperforming the other asset classes amid the turn in inflation and the reduction in weekly supply. Property lost 1.0%. For 1Q18, the ALBI was the top performing asset class, rising by 8.1%, followed by fixed-rate credit (4.5%), ILBs (4.1%), cash (1.76%), and floating-rate credit (0.7%). Property was the quarterly laggard at -19.6%.
At 8.20% SA nominal bonds are only modestly undervalued versus our tactical fair-value estimate of 8.00%, but still offer over 3% on a real yield basis.
Equity market developments
Following an exceptionally strong start to the year, global equity markets sold off sharply in February amid concerns about rising inflation, monetary policy tightening, and the unravelling of short volatility positions and funds. The retreat in the VIX has been temporary, with the risk gauge moving back above 20 during March. The S&P 500 has not been able to revisit the record-high reached in January, rather it has retested the lows reached in February. The MSCI World Index lost 2.4% in March, while the MSCI Emerging Markets index outperformed only marginally (-2.0%). For 1Q18 DM equities are down by 1.7%, while EM equities have gained 1.1% in dollar terms and 0.4% in local currency terms.
The ALSI (-4.18%) and SWIX (-5.00%) underperformed global equity markets in March. The decline during the month was enough to erode the strong start to 2018, resulting in a quarterly loss of 5.97% for the ALSI and 6.76% for the SWIX. The weakening bias can be ascribed to global market pressures, in particular the tech rout, a stall in the bond market rally, over-optimism on the local economic recovery, renewed policy uncertainty, a turn in the earnings revision bias, and moderating offshore FPI inflows. On a sectoral level, positive performance during March was limited to forestry and paper (3.17%), gold mining (6.10%), non-life insurance (8.24%) and health care equipment and services (4.91%). The sharp underperformers were household goods (-43.1%), technology (-25.6%), industrial metals (-15.4%), platinum mining (-15.2%), and media (-11.6%). Despite the near 19% plunge by end-February, the listed property index lost a further 1.0% in March as governance concerns persist.