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.

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 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 Monetary Policy committee (MPC) voted unanimously to keep the repo rate on hold at 6.75% at its meeting on the 21-23 November. The decision was accompanied by a more hawkish statement given the deterioration in the inflation outlook due to the weaker rand and higher oil prices. The MPC also provided policy guidance for the first time, suggesting that the Repo rate could be hiked three more times by the end of 2019. The South African Reserve Bank (SARB) revised its inflation forecast higher to 5.2% and 5.5% in 2018 and 2019 from 5.0% and 5.3% respectively. The Bank maintained that the risks to the inflation outlook are on the upside.

The MTBPS in October unveiled significant slippage and a huge widening in South Africa’s debt to GDP ratio. The budget deficit for 2017/2018 financial year widened to 4.3% of GDP compared to 3.1% of GDP announced in February’s budget. The rand weakened to trade above 14.40 to the US Dollar, and bonds sold off to their yearly highs.

Given the fiscal deterioration highlighted in the MTBPS, rating agency S&P followed through on the negative outlook, and on the 24 November announced its decision to downgrade South Africa’s long-term local and foreign currency rating by one notch to sub-investment grade (Junk), while Moody’s placed South Africa on review for a possible downgrade.

The market friendly outcome of the major political event (ANC elective conference), caused a strong rally in the Rand and bond market. The ANC elected Cyril Ramaphosa as its new President. The positive sentiment was driven by widespread speculation that Mr Ramaphosa will address the need for transformation to reignite growth and rebuild investor confidence despite the many challenges South Africa faces. The Rand strengthened around 9% against the US Dollar after the announcement, and ended the quarter at 12.38.

The money market yield curve flattened toward the end of the quarter. The 1 year NCD rate traded at a high of 8.35% after the MPC’s decision not to cut interest rates and more hawkish statement. The 3mth Jibar rate moved 17basis points higher to 7.158% while the 1 year NCD rate closed at 7.80%.