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Economic and market review 31.03.2018

Economic and Market Review

Our monthly write-up of the markets.

Decisive action under new leadership

Local developments continued to be the primary driver of improved investor sentiment during the first quarter of 2018. Hope of much needed change in policy direction following the outcome of the ANC Elective Conference in December 2017 received several boosts along the way as the new cabinet asserted itself with decisive action and initiatives.

Cherry on top was the tabling of a more market friendly national budget

From a pure bond market perspective, the main highlights of the above are important governance related changes at Eskom and other troubled state owned enterprises and the tabling of a more market friendly national budget. Consequently, investor and consumer sentiment received a boost, as evidenced by the significant improvement in several Business and Consumer Confidence Indices; a crucial element to lifting lacklustre and sub-trend economic growth. The changes enticed foreign bond investors to return to the local market following the selling spree in the aftermath of the tabling of a shocking Medium Term Budget Policy Statement in October 2017. At the end of March, net foreign investor purchases of local currency bonds reached R25bn, a significant positive swing considering net selling of around R6bn earlier this year. 

Changes enough to convince Moody’s rating agency to change tack

Investor action served as a precursor to the decision by Moody’s rating agency to retain South Africa’s sovereign credit rating at Baa3, the lowest investment grade rating. Although the likelihood of an unchanged rating was already priced by the market, the decision to change the sovereign outlook from negative to stable was telling in terms of the agency’s view on the impact of recent political changes. In contrast, Standard and Poor’s Rating Agency released a more sober report where the difficulty of solving South Africa’s structural issues featured strongly.

SARB utilised the window of opportunity to ease policy 

The confluence of Moody’s ratings decision, which prevented the large scale selling of SA bonds by foreign investors, sustained rand strength, meaningfully lower inflation expectations and improved sentiment following recent political changes enabled the South African Reserve Bank to lower the repo rate by 25 basis points in March. However, the role played by a stronger rand in stemming the improvement in the balance of payments did not go unnoticed. 

Bond market responded with magnificent returns 

The strength of the bond bull rally is well illustrated by the movement in the benchmark RSA R186 Government Bond (maturity 2026). The R186 yield dropped from a recent weakest yield of 9.47% in mid-November to close at 7.99% for the first quarter of 2018. For the quarter under review, the drop in yield was 60 basis points. Longer dated bond yields compressed even more, with the longest dated RSA R2048 Government bond (maturity 2048) compressing by 83 basis points. The yield curve as a consequence flattened over the quarter. As a result, the All Bond Index rendered a total return of 8.1% for the first quarter. In stark contrast, cash returned a mere 1.6%.

Inflation-linked bonds stronger despite benign inflation backdrop 

The sharp decrease in nominal bond yields also dragged real yields to lower levels, despite the fact that the demand for inflation protection had been less urgent considering the more benign inflation outlook. Although still well below the return offered by nominal bonds, the Inflation-linked Government Bond Index still managed a very respectable return of 4.1%.  


Key macroeconomic themes

Economic growth

A moderate global economic recovery remains our base case, with a sustained, strong US economic recovery still leading the way. The significant loosening of US fiscal policy will contribute to this, although this expansionary attempt by the US government could be moderated by tightening monetary policy. Even so, we believe that the global recovery will continue to be structurally lower than in previous cycles, mainly due to lower productivity growth, ongoing broad-based balance sheet repair (deleveraging) and shifting demographics (ageing populations tend to save more and spend less).

Locally, the biggest impediment to higher local growth remains of a structural nature. Despite the seemingly improving socio-political backdrop, without urgent macroeconomic policy reform, any short-term cyclical upswing from the primary and secondary sectors of the economy will prove inadequate in addressing South Africa’s economic growth ills. The low growth trap largely remains the result of a policy vacuum, policy uncertainty, weak consumer and investor confidence and a rigid labour market. Recent political developments would have lifted confidence, and the intent to improve policy clarity is welcomed. While acknowledging the positive steps towards improved governance with the reconfiguration of Eskom’s board, state-owned enterprises still largely remain a negative risk to the fiscus, and as a consequence, economic growth.


The synchronised rise in energy and other raw material prices in the past few months has started showing in headline inflation numbers in many economies. Although global reflation is welcomed, since this is what policy makers had aimed to achieve, the feed-through to underlying inflation remains unconvincing. Final demand is simply not yet strong enough to cause inflation in most developed economies to sustainably breach central bank targets.

Locally, the telegraphed drop in food inflation and a broadly neutral currency view results in our 2018 annual average inflation forecast of 4.7%. Recent rand strength, in response to the perceived market friendly outcome of the ANC Elective Conference, should contribute to a benign inflation outlook this year. The net impact of recent tax changes, the one percentage point VAT hike in particular, is negligible to our inflation outlook.


Significant recent rand strength, and a loss of competitiveness relative to peers, is undoing some of the earlier benefit of rand weakness to the overall balance of payments improvement. As a result, we expect a marginal widening of the current account balance from an annual average of -2.0% of GDP in 2017 to   -2.7% and -3.2% in 2019. The unfavourable income account deficit (primarily comprised of net dividend and interest payments to foreigners) remains a considerable drag on a sustained and meaningful balance of payments correction. A stronger currency may continue to impede a narrowing of the current account deficit over the medium term. 


Now firmly down the path of monetary policy normalisation in the US, we agree with the Federal Reserve’s continued intent to follow a slow and gradual monetary policy normalisation process. With an unemployment rate seemingly marching to 4% and inflation pressures gradually building in the US, we believe that the Federal Reserve should continue with its interest rate normalisation process. If anything, we are of the view that it may be in a position to raise rates by more than what is currently priced by markets, i.e. by as much as another 75 basis points, this year. While the Federal Reserve intends to reduce the size of its balance sheet in an interest rate neutral manner, we are of the opinion that the sheer size of this reduction should contribute to a gradual lift in the ceiling for US Treasury yields, especially if the economic recovery continually gathers momentum. In addition, the expected widening of the Federal budget deficit for the forthcoming fiscal year on the back of strong economic growth momentum will create additional scope for monetary policy normalisation.

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 (ECB) and Bank of Japan will retain their respective quantitative easing and negative interest rate policy programmes, but with some tweaks. In the case of the ECB this will continue to take the form of a slowdown in the pace of quantitative easing. All told, we expect central bank hawks to slowly gain some ground over the next few months.

Following the recent widely expected 25 basis points repo rate reduction, the South African Reserve Bank is expected to become more cautious. We fully support this defensive stance. Considering renewed (albeit relatively limited) weakening pressure on the balance of payments, the fact that actual inflation is hovering around the mid-point of the target range, inflation expectations still largely stuck closer to the top end of this range and indirect support from very loose global monetary policy slowly waning, we deem a neutral policy stance the most appropriate course for local monetary policy. We therefore disagree with the forward rate market’s pricing of more repo rep rate cuts for the remainder of this year.


Following the tabling of a less alarming national budget in February, National Treasury is still confronted by a very challenging fiscal path. Admittedly, the gross debt to GDP ratio estimates for the next three years are lower compared to the October 2017 estimates, but it is still worse than the estimate a mere twelve months ago. As we have previously highlighted, structurally weak domestic growth is severely impeding the consolidation of SA’s budget balance. We now look to the actual delivery of fiscal and wide-ranging State Owned Enterprise (SOE) reform to reinvigorate consumer and business confidence as the scope to steer SA Inc. towards a sustainable growth path quickly narrows. 

Investment view and strategy 

Our view remains that, despite the recent pick-up in global bond yields, developed bond markets are still not appropriately priced. In our view, the Federal Reserve is in a position to lift the policy rate by another 75 basis points this year. The fact that the US has opted to loosen fiscal policy significantly at a time when positive economic growth has already gained sustainable momentum partly supports this view.

Locally, our main concern with regards to the bond market remains the strong link between lacklustre economic growth and fiscal consolidation - or more specifically the rising debt burden of government. Recent political changes, action with regards to SOE management and the tabling of the latest budget most certainly went some way to reduce some of the concerns we previously had. However, it would also be irresponsible to ignore fiscal execution risk. The structural nature and extent of the country’s macroeconomic ills require significant policy adjustment, time and effort to resolve.

Our view on monetary policy also remains more cautious than what has been priced by forward money market rates. We do not subscribe to a view of further interest rate cuts in this cycle. Inflation expectations are hovering closer to the top end of the 3-6 percent inflation target range, actual inflation is merely back to the middle of this range, while monetary policy tightening in some parts of the developed world should not go unnoticed. The current account deficit is at risk of widening as a result of a stronger rand, slightly stronger local economic growth and leakage from net negative interest and dividend payments. At current levels, the bond market is not priced for bad news. As a result, we would maintain our slightly defensive stance, while utilising opportunities to enhance the running yield of our funds.

As a result, our broad interest rate investment strategy remains defensive. In the case of our Core Bond Composite (benchmarked against the All Bond Index), this is expressed as follows:



Key economic indicators and forecasts (annual averages)


    2014 2015 2016 2017 2018 2019
Gobal GDP   2.8% 2.9% 2.5% 3.3% 3.6% 3.2%
SA GDP   1.5% 1.3% 0.3% 1.3% 2.3% 2.5%
SA Headline CPI   6.1% 4.6% 6.3% 5.3% 4.7% 5.0%
SA Current Account (% of GDP)   -5.4% -4.4% -3.3% -2.0% -2.7% -3.2%

Source: Old Mutual Investment Group