Markets hunt for signs of an ease in the pace of monetary policy tightening
Unsurprisingly, most central banks kept to their relentless policy tightening script in response to the worst inflation episode in decades (for advanced economies). In many cases, policy rates are currently at their highest level since 2008. For now, the hawks are still firmly in control, with phrases like “should continue normalising and tightening policy”, “inflation risks are still to the upside” or “inflation is still elevated” abounding. Even so, the cautious mention of carefully selected words like “slowing”, “pause” and “cut” have started to surface more recently as policy makers acknowledge the rising risk of prolonged and deeper recessionary conditions. For instance, the US November Federal Open Market Committee meeting minutes revealed a growing, if fragile, consensus among committee members on a potential slowdown in the pace of future tightening. This is linked to an increasingly weaker growth outlook and the fact that inflation is rising at a slightly slower pace, even though this is mainly due to favourable base effects. As one would expect, financial markets tend to look beyond short-term noise. In the case of the US, the recent decline in longer-dated treasury yields (and consequent yield curve bull flattening) signalled rising investor expectations of a near-term peak in both inflation and policy rates. Of course, this is not the case across all economic regions. In the UK and Euro zone, where monetary policy response has ambled somewhat to the worst inflation experience in four decades (partly due to the Ukraine/Russia conflict) the peak is still obscured by a dark inflation cloud. Data and events of the past two months or so are increasingly pointing to the start of a possible decoupling across economic regions, specifically regarding inflation and monetary policy dynamics.
The South African Reserve Bank sticks to hawkish action and messaging
Like its more hawkish monetary policy counterparts, the South African Reserve Bank (SARB) increased the repo rate by a widely expected 75 basis points (bps) at the November Monetary Policy Committee Meeting. While the committee and, in particular, the governor of the SARB went the extra mile to emphasise what would be needed for a pause, the fact that two of the five voting members opted for a 50bps rate increase could be interpreted by bulls as an early sign of a potential ease in the pace of future tightening. That said, one of the pre-conditions for an ease or pause is confirmation that the rate of inflation has decelerated to levels closer to 4.5% (the mid-point of the inflation target range). This is clearly still some way off. While we view a repo rate of 7.0% as the peak in the cycle, it is important to acknowledge the risk of one more hike of between 25bps to 50bps, possibly at the January MPC meeting. The governor’s remark “the cost of hiking too much is lower than the cost of hiking too little” should not be ignored. In the end, the SARB needs to be convinced that inflation expectations will remain contained.
Figure 1: Inflation to dip below the nominal repo rate next year
Source: Bloomberg, Futuregrowth
Local inflation keeps heading lower, but this is not smooth sailing
The South African Headline Consumer Price Index (CPI) accelerated by 7.6% year-on-year in October from 7.5% the previous month, disappointing market consensus which was looking for a more pronounced slowdown in the rate of increase. More concerning was the acceleration of Core CPI by 5.0% from 4.7% the previous month, with evidence that price pressure is broadening. This inevitably boosted the case of a 75bps repo rate hike at the November MPC meeting. On a more positive and forward-looking note, the year-on-year increase in the Producer Price Index (PPI) for final manufactured goods slowed to 16.0% from 16.3% in September and is now well below the PPI cycle peak of 18.0%. A potentially more appropriate indicator of future consumer inflation is easing price pressure for a broad basket of producer goods down the value chain, including the agriculture, forestry and fishing sectors. We believe that this will filter down and support the expected disinflation trend in coming months.
The merchandise trade account surplus swings into a deficit
It had always been expected that the very significant terms of trade gains that reached a peak earlier this year (partly as a result of the Ukraine/Russia conflict) are not sustainable. Apart from the recent negative impact on the terms of trade caused by the retracement in earlier high coal prices, export volumes are increasingly hampered by a number of factors. This includes weakening global economic activity, frequent COIVID-related interruptions in China and localised drivers such as intensified load shedding and poor service delivery by Transnet. Even so, the large swing in the merchandise trade balance from an upwardly revised R26 billion in September to a R4 billion deficit in October (the first since April 2020) surprised even the bears. This large swing was largely the result of a massive 17% month-on-month decline in exports. While the factors mentioned all contributed, the extent of the monthly change suggests that this mainly reflects the devastating impact of the Transnet strike that ended in October. While it could be assumed that the November data may show some rebound in exports as backlogs are cleared, the broader weakening trend remains entrenched.
South Africa’s sovereign credit rating and outlook is confirmed
International rating agencies S&P and Fitch Ratings affirmed South Africa’s foreign and local currency ratings at BB- with a positive outlook. Although it did not issue a statement, Moody’s effectively followed the same action at its biannual review date. The affirmation was largely expected, which explains a muted if not a complete lack of market response. While the rating agencies kept the ratings and outlook unchanged, South Africa’s low economic growth potential, slow progress with growth boosting reforms and significant risks to sustained fiscal consolidation were once again flagged as risks. These concerns are aligned with our long-held scepticism about the ability to lift the country’s potential growth rate to a sustainable higher level in the absence of significant and bold structural changes and, in turn, to create an improved environment for quicker, much-needed fiscal consolidation.
Figure 2: South Africa is better priced than its official credit rating profile implies (Five-year credit default swap spread relative to S&P foreign currency ratings)
Source: Bloomberg, Futuregrowth
The political backdrop enters troubled waters
The announcement by a special parliamentary panel that President Ramaphosa had a case to answer for with respect to a possible violation of anti-corruption laws complicates his campaign for re-election at the December ANC Elective Conference. The president also faces the possibility of impeachment by Parliament, which would require a two-thirds majority of members to support it. More importantly, the developments of late complicate progress with much-required improved macroeconomic policy certainty and structural reforms. This undoubtably will add a layer of uncertainty to general market sentiment, in turn contributing to higher return volatility.
Both nominal and inflation-linked bonds delivered cash-beating returns in November
November turned out to be less volatile for the local bond market compared to previous months, at least partly due to newfound strength and a higher degree of stability in most global bond markets. Stronger global bond markets, a recovery in the rand (at least in part due to some US-dollar weakness) and a hawkish SARB combined to allow room for lower nominal bond yields. As a result, the FTSE JSE All Bond Index (ALBI) managed to deliver a strong 3.9%. Following a brief period of significant weakness, ultra-long-dated inflation-linked bonds managed to recover some lost ground during November. The decline in real yields, partly boosted by a slightly higher than expected October CPI reading and improved valuation following the poor run in October, allowed the FTSE JSE Government Inflation-linked Bond Index (IGOV) to return a stronger 0.8% in November. For the year ending November, the IGOV returned 1.5%, lagging both nominal bonds (3.6%) and cash (4.4%) over this period.
Figure 3: Bond market index returns (periods ending 30 November 2022)
Source: IRESS, Futuregrowth
// THE TAKEOUT
Globally, monetary policy tightening has kept gaining momentum, with central banks focused on getting the inflation genie back into the proverbial bottle. Global bond markets continued to enjoy some reprieve during November as attention shifted increasingly to weaker economic data, evidence that inflation pressure is slowly easing in some regions. This increasingly dampened market expectations of policy tightening going into the new year. The SARB raised the repo rate by an expected 75bps, taking the repo rate to our estimate of the peak in this cycle. Locally, both CPI and PPI data prints confirmed the start of the disinflation trend, even though the former disappointed expectations with a higher year-on-year increase. Against this background, the nominal bond market performed relatively well despite some intra-month volatility. The inflation-linked bond market managed to recover some of the previous month’s losses as real yields drifted lower from elevated levels. As a result, the ALBI rendered a recent return of 3.9%, outperforming both cash (0.5%) and the IGOV (0.8%) in November.
