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Economic and market review 01/2017

Economic and Market Review

Our monthly write-up of the markets.

Global inflation is gaining momentum

Bond bears would have been delighted at the sight of more evidence of higher inflation in some of the key developed markets in the last while. What is more encouraging to both these bears and policy makers in particular, who for years have frantically dug deep into the monetary policy tool chest to avert deflation, is the fact that latest inflation data releases have generally surprised consensus forecasts to the upside. It certainly appears that the so-called reflation trade continues to gain momentum, which in turn should keep bond markets on the back foot. However, it is important to note that most of the upward pressure on inflation is still mainly as a result of rising energy and raw material prices. Strong feed-through to core inflation is still lacking, mainly due to persistent economic slack.

Upward momentum to US bond yields faded somewhat

For this reason, upward momentum to key bond yields faded somewhat in January, most notably in the US. This was not the case with some European bond markets though. Here the combination of slightly improved economic activity, higher headline consumer inflation and rising political uncertainty forced yields higher. This brought significant capital losses to those who bought bonds at lower yields barely a few months ago.

Better bid to local bonds backed by stronger rand      

The impact of the above on the local bond market was diluted by rand appreciation, partly reflective of downward pressure on the US dollar. The better than expected (seasonally unadjusted) monthly trade balance played a secondary role. The strong US dollar consensus trade encountered a few setbacks of late, including awkward attempts by the Trump administration to “talk down” the US currency. The local bond market also largely shrugged off slightly higher than expected inflation data releases, while managing to absorb net selling by foreign investors. As a result, local bond yields ended a fairly volatile month marginally lower with the All Bond Index delivering a reasonable return of 1.3%.

Stable monetary policy while political risk lingers    

On the policy front, the South African Reserve Bank left the repo rate unchanged at its first Monetary Policy Meeting of the year. This was in line with broader consensus. The Monetary Policy Committee did surprise by releasing an upward adjustment to their inflation forecast though. We believe that this inflation forecast update is too bearish. Monthly data on the fiscal side implies that National Treasury remains on course to match their October 2016 deficit estimate, although we think that the risk is skewed to a small shortfall. Although political noise has died down a little, uncertainty still hovers, especially caused by persistent rumours of an imminent cabinet reshuffle.

Another foreign currency ratings reprieve, but the outlook remains negative    

Moody’s rating agency made no changes to its South African sovereign ratings, remaining the most bullish of the three agencies as Fitch changed its previous stable outlook to negative, implying a higher risk of a sub-investment sovereign rating. S&P Global Ratings reduced the local currency rating one notch, while retaining the overall negative outlook. With South Africa now on negative watch with all three major rating agencies, pressure remains to deliver on more comprehensive structural reforms instead of the recent “piecemeal” flurry of announcements. On a relative basis, the pricing in the Credit Default Swap market (where investors can hedge themselves against the risk of default), suggests that the market is still priced for a downgrade to sub-investment for the country. We remain in agreement with the market on the prospects of a future sovereign credit rating downgrade, based mostly on our inability to sufficiently address the structural impediments to growth.

Summary of macroeconomic outlook, market view and investment strategy

Key macroeconomic themes

Economic growth

A mild, uneven global economic recovery remains our base case, with a relatively strong US economy still leading the way. The Trump presidential victory (together with a House and Senate Republican majority) boosted speculation that higher US fiscal spending will benefit the US growth trajectory. This remains to be seen and for now the risk is that markets may have to face disappointment with respect to both the timing and size of the much anticipated stimulus. We believe that the global recovery will be structurally lower than in previous cycles, mainly due to lower productivity growth, ongoing broad-based balance sheet repair (deleveraging) and shifting demographics (older populations tend to save more and spend less).

Most emerging market economies are caught between an improved, but still mixed outlook for the developed world, the implication of structurally lower Chinese economic growth on commodity demand and the US Federal Reserve’s well telegraphed intent to normalise monetary policy. Therefore, commodity producers with large external imbalances, such as SA, remain vulnerable.

Locally, the biggest impediment to higher local growth remains of a more structural nature. Encouragingly, overdue engagement between government and business raises the prospect of unlocking some domestic growth potential – but prompt and practical follow through is still necessary for it to be impactful. Unfortunately, the jury is still out on actual delivery, which if it happens, can only be expected to produce results in the long run.


The strong rise in energy and other raw material prices over the last few months has started showing in headline inflation numbers in many economies. Although reflation is welcomed with open arms, since this is what policy makers have aimed to achieve, the feed-through to underlying inflation is still not entirely convincing. Final demand is simply not yet strong enough.

Locally, the expected drop in food inflation and the stronger rand in the last few months have forced down our 2017 annual average inflation forecast to 5.5%


Significant rand depreciation until a few months ago and an improved terms of trade position are lending relief to the balance of payments. As a result, we expect a narrowing in the current account deficit from an annual average of 4.4% in 2015 to 3.7% in both 2016 and 2017. However, even at these improved levels, SA is still saddled with a relatively weak external trade position (both in nominal and relative terms). The unfavourable income account deficit (primarily comprised of net dividend and interest payments to foreigners), has become a significant drag on a sustained and meaningful balance of payments recovery. This may remain a drag on the currency.


Having finally started the long awaited and well telegraphed monetary policy normalisation process, we agree with the Federal Reserve’s intent to follow a slow and gradual process. With an unemployment rate seemingly stuck below 5%, slowly-rising wages and the more stable PCE core inflation rate now hovering at 1.7%, we believe that the Federal Reserve should continue with its interest rate normalisation process, but for obvious reasons at an appropriate pace.

The current trend of global monetary policy divergence is expected to continue over the next year or so. With more policy tightening in the US on the cards, the European Central Bank and Bank of Japan will retain their respective quantitative easing and negative interest rate policy programmes, with some tweaks. At the same time, some of the smaller advanced and commodity-driven economies may be forced to ease policy, mainly due to below-trend economic growth and a modest inflation backdrop. On the positive side, monetary policy divergence will act to soften the impact of higher US rates on global growth.

In the case of SA, we feel comfortable with the prospect of the South Africa Reserve Bank (SARB) being at the peak of the interest rate tightening cycle. A cautious approach is supported by the weak economic growth backdrop, low levels of credit extension growth and limited evidence of demand-led inflation. However, considering the size of the balance of payments deficit and the stickiness of inflation (in the upper end of the target range), we deem a neutral policy stance (thus no cuts) as the most appropriate course for monetary policy for now.


The Minister of Finance followed the realistic and balanced national budget delivered in February with a reasonable Medium Term Budget Policy Statement, considering very challenging circumstances. However, we cannot ignore the marginal slippage relative to the February commitment on the planned consolidation path, which has indeed confirmed our fears of elevated execution risk in the outer years of the Medium Term Expenditure Framework. While bearing cognisance of a raft of new policies aimed at improving the governance of state-owned enterprises (SOEs), the financial state of some SOEs, and the implications for a finely balanced fiscal position, remain a significant concern. Our concern about the implication of this on the already high level of contingent liabilities at a national level remains elevated.

At a macro level, discussions around structural economic reform seem to have yielded some fruit, with a suggested minimum wage of R3 500. However, a number of policy initiatives are still unresolved and more needs to be done than the piecemeal announcements made thus far. This includes important changes to mining legislation as well as agreement on secret strike-balloting. The risk we run from a credit ratings perspective is that the lack of promised structural reforms start weighing more than the strengths offered by monetary and fiscal policy credibility.

Investment view and strategy 

With the exception of the US, and more encouraging signs of some improvement in other G10 countries, the global growth recovery still remains fragile. This sets the scene for a modest rise in inflation as well as monetary policy divergence. It also implies a steady tightening cycle for the few economies that are in a position to normalise monetary policy, especially the US. This should limit significant upside to global bond yields, especially following the recent bearish correction. On the negative side, the continued uncertainty about the global, and particularly the Chinese growth outlook remains a risk − especially for emerging market commodity producers with a weak external position in both absolute and relative terms, like South Africa. The anti-global trade tirade by the Trump administration is expected to add uncertainty to the mix.

Locally, the downward trend to inflation is imminent, mostly supported by significantly lower food price increases. While the South African Reserve Bank has now adopted a neutral bias, it is unlikely that they would consider interest rate cuts soon. The external imbalance is simply too big to allow for a lower real repo rate, while unpredictable currency swings continue to pose a risk to the more benign inflation outlook. Although the Minister of Finance is clearly determined to rectify the damage to fiscal policy credibility and, by implication, to avoid a sovereign credit downgrade to non-investment grade status, the jury is still out on actual delivery. Therefore, the risk of a credit rating downgrade over the next 12 months still hovers. In the short term, local political uncertainty remains a nagging risk. It is hard to ignore the persistent rumours about an imminent cabinet reshuffle.

Considering the above, we will continue to approach the market with caution. The emphasis therefore remains on capital preservation. This is expressed by the large underweight modified duration and 12+year nominal bond positions. We have reduced our inflation-linked bond exposure to a zero holding in response to the more benign twelve month inflation outlook and instead opted to retain an overweight position in short- and medium-dated nominal bonds. The biggest risk to our cautious stance is US dollar weakness and consequent rand strength.

Considering the above, we will continue to approach the market with caution. The emphasis therefore remains on capital preservation. This is expressed by the large underweight modified duration and 12+year nominal bond positions. We have reduced our inflation-linked bond holding over the past quarter in response to the more benign twelve month inflation outlook and have instead opted to create an overweight position in short- and medium-dated nominal bonds. The biggest risk to our cautious stance is sustained net foreign inflows into the local nominal bond market.

Our broad interest rate investment strategy for a core bond fund benchmarked against the ALBI is as follows:

  • Modified duration - Underweight (80% of maximum allowable range)
  • Cash - Small overweight
  • Nominal bonds (1-12 years) - Overweight
  • Nominal bonds (12+ years) - Underweight
  • Inflation-linked bonds - Zero holding

Monthly review &

Latest news

Key economic indicators and forecasts (annual averages)

    2013 2014 2015 2016 2017 2018
Global GDP  
/ USA   1.9% 2.4% 2.4% 1.5% 2.0% 2.0%
/ Euro area   -0.4% 0.9%


1.6% 1.5% 1.5%
/ Japan   1.6% -0.1% 0.5% 0.7% 1.1% 1.3%
/ China   7.7% 7.4% 6.9% 6.7% 6.4% 6.2%
SA GDP   2.2% 1.5% 1.3% 0.5% 1.3% 1.5%
SA Headline CPI   5.8% 6.1% 4.6% 6.3% 5.5% 5.4%
SA Current Account (% of GDP)   -5.8% -5.4% -4.4% -3.7% -3.7% -4.0%