Nominal bonds stage a small recovery
July turned out to be relatively calm from a market perspective. The South African Reserve Bank (SARB) opted to reduce the repo rate by 25 basis points (bps) to 3.50% at the July Monetary Policy Committee Meeting. As a result, the yield curve bull steepened, with the 3- to 7-year maturity band delivering a superior return of 1.50%. Bonds in the 12+ year maturity band rendered a return of 0.00% as the fast deteriorating fiscal situation continues to cap the upside to ultra-long-dated bond returns.
The strong performance of short-dated bonds enabled the All Bond Index (ALBI) to return 0.61%. The combination of low inflation and rising real yields once again snookered inflation-linked bond returns. As a result, the FTSE JSE Government Inflation-linked Index (IGOV) returned a disappointing -1.19%, well below that of nominal bonds and cash which returned +0.32%.
Figure 1: Index returns for periods ending 31 July 2020
Source: JSE, Futuregrowth
Indications are that economic activity continued recovering from exceptionally weak levels, while inflation remains at subdued levels
Economic activity continued to recover even though it is still well below pre-COVID-19 levels. Indicators such as electricity demand, new vehicle sales and manufacturing activity all rebounded from the collapsed levels in April. Even though this is welcome news, the sustainability of the rebound should be questioned. One indicator calling for caution is the continued sharp slowdown in underlying corporate and household credit extension, a clear signal that both sectors are under significant duress, while lenders have also become more risk averse. The year-on-year June Headline Consumer Price Index (CPI) print of 2.2% suggests that the inflation trough in the current cycle may have been recorded in May at 2.1%. All said, inflation is likely to remain subdued, given very limited inflationary pressure.
Another large trade surplus
One of very few silver linings linked to the collapse in economic activity is the 19% month-on-month slowing in merchandise imports in June. This slowing in import demand, combined with a 10% month-on-month increase in merchandise exports, gave rise to a positive trade balance of almost R50 billion, which bodes well for a current account surplus – a welcome development from a currency perspective.
June fiscal data confirms an expected collapse in tax revenue collection
While the release of June fiscal data failed to impact market sentiment, it confirmed the worst fears of the expected devastating impact of the nationwide lockdown. The sharp 23.6% cumulative year-on-year collapse in total government revenue not only reflects the dire economic consequences of the COVID-19 induced crisis, but also raises an alarm about the credibility of government’s latest fiscal estimates. This concern is shared by the International Monetary Fund, which, following the approval of a USD4.3 billion loan under the Rapid Credit Facility, warned the country about the risks to debt sustainability - and reiterated the urgency of corrective steps.
Figure 2: Tax revenue collection falling off a cliff (year-on-year change)
Source: National Treasury, Futuregrowth
// THE TAKEOUT
While economic activity appears to be picking up, it is still well below pre-lock down levels and, for now, at risk of staying at relatively weak levels. This does not bode well for a fast deteriorating fiscal situation and unfortunately supports our scepticism about government’s ambitious expenditure reduction plan.