Central banks are firmly set on taming inflation
Globally, central banks (with the exception of the central bank of Turkey, where political meddling blocks sensible macro policy management) continued to up the ante with an increasingly aggressive policy response to sustained broad-based inflation pressure. In stark contrast to their earlier tendency to underestimate the pervasiveness of inflation, the belated central bank hawkishness seems to increasingly supersede sensitivity to the impact of higher rates on economic activity. In the largest economy in the world, the US Federal Reserve lifted its policy rate by 75 basis points, the largest single increase since the 2008 global financial crisis Similarly, the South African Reserve Bank continued on the policy normalisation path by raising the repo rate by 75 basis points, with one of the five voting members calling for a 100 basis points increase. At 5.5%, the repo rate has now been increased by a cumulative 2.0% from the post-COVID low.
Figure 1: Global inflation is well above the 10-year average
Source: Bloomberg, Futuregrowth
Sovereign bond yields drifted lower from overextended levels
Softer economic data releases (including a host of weak PMIs and US GDP data) and rising investor concerns about the added negative impact of fast rising policy rates on economic activity exerted downward pressure on sovereign bond yields. The lower bond yields imply market expectations of disinflation and weaker economic growth by next year, which in turn would force central banks to start unwinding the current bout of monetary policy tightening. This also ignited some risk appetite, with investors dipping into various financial markets now offered at more enticing valuation following the broad-based market correction in recent months.
Figure 2: Central bank policy rates in most markets are above the lows of a year ago
Source: Bloomberg, Futuregrowth
South African inflation keeps heading higher, along with the global trend
Being a small open economy and a net importer of oil, South Africa is not escaping the global turmoil unscathed. On the inflation front, the country’s Headline Consumer Price Index (CPI) accelerated by 7.4% year-on-year in June from 6.5% the previous month. Unsurprisingly, a marked annual jump of 45.3% in fuel prices, and a 9.0% increase in year-on-year food inflation continue to be the primary drivers of this sharp acceleration, the highest in 13 years. While Core CPI rose by a more subdued 4.1% in May, from 3.8% the previous month, the acceleration was broad based and included the previously well-behaved rental and services components. Also concerning, and closely aligned with global developments, is the continued sharp acceleration of prices at the producer level, with some risk of spillover to consumers. In June, the Producer Price Index (PPI) for final manufactured goods accelerated from 14.7% in May to 16.2% on a year-on-year basis, the highest since 1989 (even though the calculation methodology has changed over time). While once again broad based, with prices in six out of nine categories rising, it was nonetheless slightly better compared to the May data set when seven out of nine categories rose. On a forward-looking and more positive note, it is worth noting that crude oil prices, global grain/food indices and SAFEX futures prices for key grain crops have started easing from exceptionally elevated levels. In addition, the Prices Paid subindex of the ABSA PMI decreased to 87.5 in July, its lowest level in eight months. While still exceptionally high, the lower reading does, at least anecdotally, point to some deceleration in the rate of price increases at the production level. It is also noteworthy that subdued global economic activity has allowed for earlier extreme supply chain pressures to start easing.
Figure 3: Higher South African inflation is creating a high base for significant disinflation next year
Source: OMIG, Futuregrowth
This has been the strongest first fiscal quarter for South Africa in 16 years
The promising start to the 2022/23 fiscal year received another significant boost in June. Data released by National Treasury revealed a main budget surplus of R73.8 billion for June, mainly due to a significant jump in corporate income tax (CIT) receipts. The year-on-year increase of 13.7% in CIT is particularly noteworthy considering last year’s bumper collection which created a high base, together with the fact that commodity prices have started rolling over since then. While personal income tax receipts slowed, these were offset by higher VAT receipts and a surge in customs duties. It is also encouraging to note that total expenditure rose by a muted 6.5% year-on-year. The impact of sustained higher-than-expected tax revenue collection and contained expenditure during the first three months of the current fiscal year resulted in a small budget surplus of R12 billion - the first in 16 years. While provisional financing data for July points to a large monthly deficit of around R83 billion, this is broadly in line with seasonal trends, and significantly smaller than the deficit recorded for the corresponding month last year. All considered, the combination of actual data for the first three months and provisional data for July continue to support our expectation of a markedly smaller budget deficit for the current fiscal year, compared to the latest official estimate.
The merchandise trade surplus is still sizeable despite strengthening headwinds
The country’s merchandise trade surplus narrowed from R30.9 billion in May to R24.2 billion in June as imports rose by more than 6%, mainly boosted by mineral products as the loss of domestic refinery capacity is believed to have forced the purchase of more expensive refined oil. The jump in imports outpaced the 1.6% rise in exports by a significant margin. While the surplus is still sizeable, the recent trend is aligned with our view of a gradual narrowing of the current account surplus.
Figure 4: South African bonds offer good value on a global scale (10-Year inflation-adjusted nominal government bond yields: local currency)
Source: Bloomberg, Futuregrowth
Government has a belated response to the ongoing and intensifying power crisis
The recent intensified bouts of electricity loadshedding forced government to finally respond with a set of more meaningful electricity reforms. The 100 megawatt ceiling for private embedded electricity generation was scrapped while independent power producers (IPPs) will be allowed to feed/sell surplus power to the grid. The doubling of electricity procurement from these IPPs through bid window 6 will add more renewable energy to the grid. Eskom’s balance sheet will also be strengthened by the proposed transfer of some of the entity’s outstanding debt to the sovereign balance sheet. While this belated/slow response to the long running energy crisis is broadly welcomed, the beleaguered South African manufacturing sector (like most other sectors) continues to be hampered in a significant way by the constrained energy supply. For instance, the seasonally-adjusted business activity of the ABSA PMI decreased sharply to 39.8 in July from 46.0 the previous month. While power shortages should not bear all the blame, the fact that load shedding was implemented for an astonishing 22 days in the month - and at an elevated intensity - would surely have had a major impact.
SA nominal bonds regained lost ground towards month end
Following a period of significant market weakness during the second quarter of the year and the first few weeks in July, longer-dated bond yields decreased sharply towards the end of the month, resulting in significant bullish yield curve flattening. The recent relief rally reflects investor endorsement of the South African Reserve Bank (SARB)’s decision to accelerate the pace of policy tightening, improved fiscal performance and, of course, lower global bond yields. The reinvestment of sizeable coupon receipts at the end of July would have boosted demand for bonds from a technical perspective. As a result, the FTSE JSE All Bond Index (ALBI) returned a heady +2.44% in July, with bonds in the 12+ year maturity band rendering an impressive 3.33%. In contrast, real yields ground higher, despite supportive inflation data prints. The increase in real yields (and consequent drop in prices) was large enough to offset the benefits of a high inflation carry. Consequently, the FTSE JSE Government Inflation-linked Bond Index (IGOV) rendered a return of -1.30%, underperforming nominal bonds by a significant margin. Even so, the return from nominal bonds still lags that of inflation-linked bonds (and even cash) for the seven-month period ending July.
Figure 5: Bond market index returns (periods ending 31 July 2022)
Source: IRESS, Futuregrowth
// THE TAKEOUT
Globally, monetary policy tightening kept gaining momentum, with central banks focused on getting the inflation genie back into the bottle. This new-found resolve has raised concerns about economic growth prospects and, in particular, the risk of broad-based recession, which in turn caused sovereign global bond yields to drift lower. Locally, the SARB kept to the monetary policy tightening script by increasing the repo rate by 75 basis points in response to broadening inflation pressures. On the fiscal front, the first three months of the 2022/23 fiscal year turned out to be the best in 16 years, as sustained strong tax revenue collection gains and subdued expenditure delivered a small budget surplus. Following 22 days of intensified loadshedding during July, the government finally managed to put forward a plan to address one of the many structural hurdles to a sustainably higher level of economic growth. A combination of the above contributed to some market gains, with nominal bonds rendering the highest return, as bond yields decreased and the yield curve bull flattened.
