At the start of November we were in the midst of a trade “war”, but by the end of the month we had a trade “truce”. At the November FOMC, everyone believed the Fed was “well” below neutral, only to hear Powell refer to “just” below neutral in his remarks on 28 November. There is potential for the UK to “unilaterally” revoke Brexit rather than “bilaterally” agree to do so. These tweaks caused a sharp reversal in US yields, allowing EM FX and local currency bond markets to rebound after the September/October risk asset rout. And in the tedious Brexit process the probability of a no-Brexit option becomes more meaningful in scenario analyses.
Yet the outlook faces another nuance: the difference between a “flat” yield curve and an “inverted” yield curve. The latter is deemed a clear message that the US is headed for a recession. We are only 13bp away from that recession. Yet the US data remains upbeat, generally meeting expectations, and inflation risks have receded, thanks to the fall in the oil price. This should limit the probability that the Fed turns more aggressive in tightening. While there is a lot of debate about the strength of the yield curve signal, history is clear, curve inversion is followed by a recession. However, there is no causality (the factors driving the inversion are important) and the lags are highly variable. Importantly, moving from above-trend growth towards trend growth is not a recession, but this negative delta may still need to be fully reflected in asset prices and asset price differentials between the US and the rest of the world.
On the local front the dynamics remain fluid. Political concerns are elevated amid ongoing policy uncertainty, but we can expected nothing more than limbo until the 2019 elections are out of the way. Parliament has adopted the Constitutional Review Committee’s recommendation that Section 25 be amended and it will now commence work on exactly what the wording should be. It is highly unlikely that this process will be concluded before the elections, which are touted for 8 May.
In another very close call the SARB opted to hike rates by 25bp to 6.75% despite a large output gap and sub-4.5% core inflation. The reason for the hike is structural – it is about neutral interest rate differentials and adaptive inflation expectations – whereas the cyclical impetus to hikes remains absent. This reflects the polarisation on the MPC. We think the timing of the hike was opportune given that it will cost the economy relatively little thanks to the 11% drop in the petrol price on the cusp of year-end driving season.
Whereas market fears have moved from the ANC leadership, to the national minimum wage, to NHI, to expropriation without compensation and SARB tightening, the factor weighing on investors’ minds now is Eskom and what it means for the fiscus. While there are nuanced implications of an equity injection versus debt support via guarantees or outright, the bottom line is that the government does not have the resources to bail out Eskom. Whatever path is chosen, the sovereign credit metrics would weaken, raising the risk that Moody’s downgrades the sovereign and so triggers exclusion from the WGBI and attendant forced selling. The size of the outflows remains hotly contested, but the impact will be negative given the substantial budget and current account deficits. Minister Gordhan has indicated that Eskom’s turnaround plan should be ready early in the New Year. Let’s hope there is light at the end of this tunnel.
Market developments
Public sector fixed-income bonds (3.9%) was the only SA asset class to beat cash (0.6%) in November, while fixed (0.2%) and floating rate credit (0.2%) delivered only marginal positive returns. Equities (-3.2%) underperformed sharply, while property and inflation-linked bonds (ILBs) bonds lost 1.3% and 1.1%, respectively.
After a surge in the dollar in October, the world’s reserve currency gained a mere 0.2% in November. The subdued move reflects the reduced safe-haven demand and the market’s reassessment of the long-term monetary policy outlook, even if US data remained upbeat and US/German 2-year yield differentials at a record high. Trade tensions temporarily thawed and with the mid-terms done some of the political uncertainty in the US receded. The stabilisation in the dollar allowed a 1.5% recovery in EM FX, but the underlying performance was mixed. Generally, countries with monetary policy tightening and undervalued currencies benefited from the risk-on environment. The rand gained 6.5% against the dollar, second only to the Turkish lira, which rallied by 7.4%. USD/ZAR traded below our 14.00 – 14.50 fair-value range during the second half of the month, but has since given back those gains and at c.14.25 is deemed fairly valued.
The UST 10-year yield tested its October highs on the back of strong payrolls and the Fed’s signal of a December hike. However, this proved short-lived as pressure on equities, the fall in the oil price, and changing rhetoric from Fed officials triggered a sharp rally in US yields. The nominal yield has fallen to 2.8%, which is the trend that prevailed from February to August, while the 10-year TIPS yields has fallen below 1.0%, but remains higher than the 1H18 level. This suggests that the much-feared wage and tariff inflation is no longer deemed a threat to US CPI. Lower US yields and stronger EM FX allowed local market rates to post reasonable gains in November (2.9%). The ALBI gained 10.2% in dollar terms with the SA 10-year yield declining by 42bp. At 9.30% the SA yield is trading comfortably inside our 9.00% – 9.50% fair-value range.
The S&P500 gained 1.8%, outperforming most other DM markets – the UK FTSE100 lost 2.1%, the German DAX declined by 1.7% and the CAC40 was 1.8% lower. The MSCI World (DM) rose by only 1.0%, falling well short of the 4.1% gain in the MSCI EM. South Africa was a relative outperformer, gaining 8.6% in dollar terms thanks largely to the appreciation in the exchange rate. The fall in the oil price and the stronger rand countered the SARB rate hike, resulting in outperformance in the general retailers (7.7%), general industrials (6.8%), media (6.6%) and banks (5.8%) sectors. However, these factors adversely affected chemicals (-15.7%) and mining (-10.3%), while beverages and tobacco (-22.7%) reflects the slump in British American Tobacco on regulatory risks in the US.
