The All Bond Index increased by 0.78% over the 3rd quarter of the year. The respective total returns were: 1-3 year +1.84%, 3-7 year +1.49%, 7-12 year +1.27% and
12+ year +0.39%.

Inflation-linked bonds returned +0.46% over the quarter, while cash was up 1.74%.

A late third quarter search for quality yield favoured attractively priced SA debt following a broad-based emerging market bond sell-off that began in August 2018. The South African benchmark yield sold-off to 9.33% in September, before strengthening to end the quarter at 8.99%. Real yields moved up marginally in the third quarter, with the largest moves taking place in the short end of the curve after consumer price inflation for August 2018 continued surprising forecasts to the downside at 4.9% against consensus estimates of 5.2% year-on-year.

Global yields trended higher on the back of strong economic data releases, with the 10-year US yield ending the 3rd quarter just over 3%. Restrictive monetary policy is currently the global economic order as economic recovery returns. The US Federal Reserve also remains committed to raising the policy rate over the coming quarters, with the committee signalling another four rate hikes between December 2018 and December 2019.

Following extended negotiations to salvage the North American Free Trade Agreement (NAFTA), a new deal has finally been reached, which seeks to resuscitate the automotive and dairy industries of the three member nations (US-Canada-Mexico). The conclusion of the new NAFTA deal goes some way to settle global trade tensions that have previously induced high volatility levels across emerging market economies in the second and third quarter of the year.

Furthermore, the introduction of SA's stimulus package announced by President Cyril Ramaphosa during the third quarter could be instrumental in anchoring positive growth expectations and avoiding a possible credit rating downgrade to junk from rating agency Moody's. Fiscal details of the stimulus package are expected to be outlined in the upcoming Medium Term Budget Policy Statement (MTBPS) as markets hope for a rebound in economic activity following a dismal start to the
year.

According to Statistics South Africa (Stats SA), South Africa's real gross domestic product (GDP) decreased for the second successive quarter in the second quarter of the year 2018 by 0.7%. This followed the first quarter's 2.6% decline in broad-based economic activity. Successive quarter on quarter contractions in GDP growth rates imply a technical recession. The largest contributors to the negative growth in GDP were: agriculture; transport and trade, each moderating by 29.2%, 4.9% and 1.9% respectively.

Notwithstanding a subdued local economic environment, elevated unemployment levels and muted pass-through inflation, the South African Reserve Bank's (SARB) Monetary Policy Committee (MPC) still remains concerned of headwind inflationary threats currently stemming from rising global oil prices, rand depreciation, and increasing electricity tariffs. Despite leaving the policy rate unchanged in September, a more hawkish MPC statement has led the market to start pricing in a more than 60 percent chance of a 25 basis-point policy rate hike before the end of the year.

The All Bond Index decreased by 3.8% over the 2nd quarter of the year. The respective total returns were: 1-3 year +0.27%, 3-7 year -1.24%, 7-12 year - 2.92% and 12+ year - 4.89%.

Inflation-linked bonds returned -4.46% over the quarter, while cash was up 1.78%.

Concerns about a rapidly increasing trade war between China and the United States dampened the global appetite for emerging market assets. A more fiscally expansive United States administration also persuaded investors to take a more cautious stance. Developed markets migration towards more restrictive monetary policy regimes has become the global economic order owing to rising inflationary pressures.

Foreign investors were large sellers of local bonds over the second quarter. Non-resident sales increased around the benchmark area of the yield curve, with the spread between the R186 and shorter R207 marginally increasing from 121 bps to 132 bps. The R186 yield peaked at around 9.2% during the second quarter and ended at 8.8% from an 8.0% low at the end of the first quarter.

The second quarter increase in the demand for cash securities came on the back of rising market volatility levels. The Forward Rate Agreement (FRA) market is currently pricing in at least one rate hike before the end of the year. Should inflation continue surprising to the downside, a hike is more likely to be deferred to the following year.

The price of Brent Crude oil increased by approximately 13% over the second quarter, moving from $70 to $79 per barrel. Combined with a rand depreciation of around 16% we can expect more cost push inflation in the coming quarters. Recent improvements in real wages as well as rising consumer confidence figures are also yet to resuscitate the presently muted demand pull factors.

1st quarter SA GDP figures surprised to the downside at -2.2% QoQ as the agricultural sector gave back some of its previous gains. Private consumption expenditure also continued to moderate as the tailwind from lower food prices waned. Unemployment figures remained stubbornly above 25%.

We currently look towards the H2 MPC policy announcements to provide further policy guidance on the balance of inflationary risks and the outlook for domestic growth.

The All Bond Index increased by 8.1% over the 1st quarter. The respective total returns were: 1-3 year +2.6%, 3-7 year +3.8%, 7-12 year +6.2% and 12+ years 10.0%.

Inflation linked bonds returned 4.1% over the quarter, while cash earned 1.8%.

The Federal Reserve Bank played to script hiking the policy rate by 25 basis points in March as was expected. The quarter began with the dollar on the back foot weakening against a basket of currencies. The Fed is expected to hike rates another 2 to 3 times this year. Political noise abounds keeping short term market moves unpredictable. US global trade relations, specifically with China have been in the spotlight. Economically, the focus is turning towards wage inflation finally coming through as the unemployment rate of 4% is effectively full employment.

The European Central Bank kept its policy rates unchanged at both their monetary policy meetings in the first quarter but have guided to ending quantitative stimulus this year. There are no changes expected to European policy rates this year but normalisation is expected early in 2019.

The oil price traded in a narrow range between $60 and $70 per barrel.

The intense and swift correction experienced in domestic fixed income market sentiment and prices after the December elective conference outcome continued throughout the first quarter as a flurry of growth and ratings positive developments took place. These included a cabinet re-shuffle that with some significant and stabilising changes, a VAT hike at the February budget, CPI moving to 4.0% YoY , a surprise outlook change to stable from negative while maintaining its investment grade rating by Moody's and a cut of 25 bp's bringing the repo rate to 6.5%. The March MPC whilst cutting rates signalled that any further change to policy rates would require inflation expectations moving closer to the middle of the target range.

4th quarter SA GDP figures surprised again to the upside with an agricultural recovery assisting the rebound to 3.1% growth (against an expectation of 1.8%) QoQ SA annualised.

The Absa Inflation Linked Income Fund maintained a neutral to conservative position over the quarter given the speed of the correction. The fund will continue to adjust its duration and exposure as required over the year ahead

The All Bond Index increased by 2.2% over the 4th quarter. The respective total returns were: 1-3 year +2.0%, 3-7 year +1.9%, 7-12 year +2.0% and 12+ years 2.3%.

Inflation linked bonds returned 1.0% over the quarter, while cash earned 1.8%.

The Federal Reserve Bank followed through on guidance, hiking the repo rate 25 basis points at Decembers meeting while maintaining the forecast of a further three 25 basis point hikes in 2018. The Fed chair Janet Yellen announced she would be leaving the Federal Reserve Bank after her successor is sworn in. Jerome Powell who will take over in 2018 is expected to largely continue with current policy and guidance. US 10 year bond yields traded in a narrow 2.3% - 2.5% range over the quarter ending the year at 2.4%.

The European Central Bank kept its policy rates unchanged at both Q4 monetary policy meetings and confirmed that stimulus through monthly asset purchases would remain until at least September 2018. European growth has been improving however inflation is only expected to return to its target in 2020.

The oil price continued to rise by around $10 per barrel to $66 by year end.

For domestic fixed income markets the October Medium Term Budget Policy Statement (MTBPS) delivered a harsh yet realistic assessment of the domestic economy. With R210bn of revenue shortfalls and a budget deficit of 4.3% of GDP this year, severe steps are required to address the weakness at next year’s budget as gross government debt to GDP is expected to reach 60%. Ratings agencies assessed the budget as a significant departure from the path of fiscal consolidation, causing S&P to downgrade South Africa’s Long term local and foreign currency ratings, now both at sub-investment grade. Moody’s has placed their rating under review and this should be resolved after the February 2018 budget. A downgrade from Moody’s to sub investment grade will result in forced selling of government bonds as South Africa will be removed from the Citibank World Government Bond Index (+/- R100 billion of bond consideration).

The December ANC elective conference concluded a year of extreme South African political volatility in South Africa, with Cyril Ramaphosa elected party president. Domestic fixed income and the currency responded favourably to this outcome.

The MPC met only once over the 4th quarter (November) and unanimously left rates on hold. Interestingly the SARB has enhanced monetary policy guidance to some extent by the more prominent reference to its quarterly projection model (QPM) which is a more rule based economic forecast model and which currently guides to 75 basis points of hikes over the two year forecast period (based on current assumptions). Nersa approved only a 5.23% tariff hike to Eskom against the MPC assumption of 8%.

3rd quarter SA GDP figures surprised, printing 2% growth (against an expectation of 1.5%) QoQ SA annualised.

The Bond fund maintained a tactically defensive position over the quarter given the potential for intense volatility surrounding political, fiscal and ratings risks over the quarter. The fund will continue to adjust its duration and exposure as required over the year ahead.