Price increases were relentless and monetary policy response slow
Inflation around the globe continued to accelerate at a relentless pace and, in the process, recorded new multi-decade highs in several advanced economies. In the case of the United States (US), headline consumer price inflation reached a year-on-year rate of increase of 8.5% in March, reflecting the broad trend in most advanced and emerging economies. What is striking is the awkward similarity to the monetary policy debacle of the 1970’s, of the pro-economic growth bias and inflation denialism of advanced market central banks over the past year. Thankfully, more and more of these central banks have become increasingly hawkish lately (and belatedly). In the case of the US Federal Reserve (Fed), official hints of an acceleration of the hiking cycle and the size of the incremental upward rate adjustments, have added to the recent spike in market nervousness. These hawkish hints turned into reality in early May as the Fed hiked its policy rate by 50 basis points (bps) for a total of 75bps in this tightening cycle. The Fed also announced much-anticipated balance sheet runoff which is to commence on 1 June as part of a more focused approach to fight inflation. Other advanced economy central banks, like the Bank of England, also tightened their policy rates, albeit in a less aggressive manner. In contrast, the politically constrained Central Bank of the Republic of Turkey could only watch with their monetary hands tied, as consumer inflation accelerated at an annual rate of 61%.
Risks to economic growth remained a concern
Recent market anxiety partly reflected rising investor concern about the ability of central banks to strike the right balance in an environment where high and rising inflation is accompanied by weaker economic activity. These stagflation concerns have reached a new level with inflation not only surprising on the upside, but downside risks to global economic activity building. In turn, this chain of events is fed by sustained supply chain disruptions, worsened by the latest round of COVID-related lockdown restrictions in China and the impact of the terrible conflict in Ukraine with no clear end in sight. At a more structural level, stagflation concerns are also fuelled by the negative consequences of a possible shift away from globalisation, which has for decades positively contributed to lower production costs while boosting economic activity across borders. It is glaringly obvious that there is only so much central banks can do to address developments beyond their sphere of influence. For this reason, markets across the different asset classes, except for some commodities, have become increasingly itchy about an increasingly difficult central bank balancing act. This was reflected by poor investment returns across global markets and a sharp kick higher in more general market indicators like the VIX volatility index in the past month. Bond yields in most advanced economies have also crept higher, with the 10-year US Treasury yield briefly breaching the 3% level.
Figure 1: Stagflation risks are rising
Source: Bloomberg, Futuregrowth
The South African rand budged in the wake of global risk aversion
In stark contrast to the first quarter of this year, the local currency lost significant ground during April. A myriad of developments combined to let the rand bears out. Sharply lower global economic activity and rising inflation accompanied by monetary policy tightening usually bodes ill for emerging markets, particularly commodity producers like SA. While SA initially benefitted from relative commodity price movements during the initial phase of the Ukraine conflict, price changes of late, including a strengthening US-dollar, point to a possible partial reversal of the earlier boost to the country’s terms of trade. This forced SA back onto the familiar path of a currency meltdown and rising bond yields in the latter half of April.
Figure 2: Rand undervalued relative to the US-dollar on an inflation-adjusted basis
Source: IRESS, Futuregrowth
Domestic economic activity faced a set-back, while inflation pressures intensified
While several leading indicators for March pointed to a reasonable outcome for economy activity, the terrible floods in KwaZulu-Natal and intensified load shedding by Eskom in April caused a short-term set-back. On the inflation front, the year-on-year rate of change of the headline Consumer Price Inflation index in March was reported at 5.9%, a tad higher than the 5.7% recorded the previous month and matching the highest reading in just over four years. Core CPI also ticked higher to 3.8% from 3.7%. More concerning is the surge in PPI for final manufactured goods by 11.9%, mainly due to the recent food and crude oil price spikes. This mirrors global developments in terms of pipeline price pressure and kept market expectations of aggressive future monetary policy tightening on the cards. With regards to the balance of payments, the merchandise trade balance widened to a whopping R46 billion in March, but with a limited impact on market sentiment due to the unfolding events described above.
SA received a sovereign ratings reprieve as the fiscal situation continued to improve
On the positive side, Moody’s changed the country’s sovereign rating outlook from negative to stable in response to an improving fiscal situation. The rating action is supported by the recent confirmation of the R326 billion fiscal shortfall for the 2021/22 fiscal year, 5.2% of GDP. The deficit was R21 billion smaller than the February budget estimate and a marked improvement on the 2020/21 budget shortfall of R550 billion or 9.9% of GDP. This improvement continued to be the combined result of stronger tax revenue collections and subdued non-interest expenditure. The South African government managed to successfully raise USD3 billion in international markets by issuing 10- and a 30-year US dollar denominated bonds. The two bonds were issued at spreads of 309bps and 447bps over the US Treasury curve respectively, which are deemed reasonable levels considering global market conditions.
Figure 3: RSA Government USD-denominated bond (spreads over US Treasury curve)
Source: Bloomberg, Futuregrowth
SA nominal bonds lost ground in April, while inflation-linked bonds shone
Against the backdrop described above, and in line with the adjustment of valuations in most global financial markets, local nominal bond yields headed higher. Moreover, the yield curve bear steepened as the yields of longer-dated bonds increased by more than those of shorter-dated bonds. As a result, the FTSE JSE All Bond Index (ALBI) returned -1.67% in April, with bonds in the 12+ year maturity band rendering a return of -2.44%. In contrast, the combination of rising inflation concerns, reasonable inflation accrual and limited net negative market activity rendered support to the inflation-linked bond market. As a result, the FTSE JSE Government Inflation-linked Bond Index (IGOV) rendered a strong return of 1.97%, outperforming nominal bonds and cash (+0.33%) by a wide margin.
Figure 4: Bond market index returns (periods ending 30 April 2022)
Source: IRESS, Futuregrowth
// THE TAKEOUT
Most global financial markets lost significant ground during April. Heightened fears about stagflation are mainly to be blamed. In turn, these fears are fed by sustained upward pressure on inflation, the influence of COVID-related lockdowns in China, the ongoing conflict in Ukraine, and concern about the impact of tightening monetary and fiscal policy on growth prospects. Broader macroeconomic developments, specifically rising concerns about the reversal of gains from globalisation, are more fundamental in nature. This continued to keep global bond yields at elevated levels. Locally, the bout of global risk aversion led to an increase in bond market volatility which led to nominal bonds rendering negative returns. In contrast to March when the South African rand managed to hold its own, the pressure from global risk aversion and a very strong US-dollar proved too much and caused the currency to be swept along by the weakening global trend.
