Local policy rates remained unchanged for Quarter 3 2013. This was widely anticipated. Consumer inflation increased over the quarter, breaching the upper limit of the South African Reserve Bank's (SARB) target range for two months. The chief driver in the higher inflation reading was petrol price increases, exacerbated by the unwinding of positive base effects.

At face value the currency had a relatively benign quarter, falling 1.4% versus the US greenback, however the intra-quarter price action was characterised by extreme volatility, with the currency trading in an 80 cent (ZAR) range. The US Federal Reserve's Open Market Committee's (FOMC's) decision to refrain from reducing its monthly injections of liquidity was the main reason for the increased volatility.

Short rates closely mirrored the price action in the currency. The initial weakening in the currency led to an aggressive liquidation in derivative transactions that would benefit from a local unchanged rate paradigm. This forced the corresponding short rates to increase to levels that where inconsistent with our view of unchanged policy rates. This in turn presented us with an attractive investment opportunity, which we capitalized on by actively extending the fund's exposure to long dated fixed rate money market instruments.

Looking ahead, we are of the opinion that inflation is near the top and should return to the target band in the coming months. We are cognisant of the risk posed to inflation by a deteriorating currency, but take note of the benign pass through to consumer prices to date. Wage settlements contribute further to our upside risk view. We remain concerned about the local outcome for the real economy in the coming months and are troubled by the effects the labour related disruptions will likely have on some supply-side sectors.

The Reserve Bank is confronted with a scenario where inflation remains uncomfortably high, but has its hands tied by a persistently weak domestic economy. In this environment, we feel that the SARB will refrain from raising lending rates for the foreseeable future. Their resolve will be bolstered by continued forward guidance by developed economies' central banks' that are currently pursuing similar strategies. As long as inflation expectations remain anchored we feel the SARB will hold fast, and as such we expect that it will actively pursue a hawkish verbal stance in the coming months. This will lead to increased volatility in the market. So long as we remain convinced of the fact that inflation expectation will remain anchored and that the pass-through from the currency remains limited, these bouts of market nervousness will offer attractive opportunities for the fund.

Euphoria and gloom were both in ample evidence over the last quarter, with the local currency again a good barometer of this; the trade-weighted rand lost 6.8% over the quarter.

April and early May saw events in the Far East dominating markets. The landslide victory of Japan's Liberal Democratic Party (LDP) in their country's general election in December 2012 led to its leader, Shinz? Abe, becoming Prime Minister. Mr Abe moved quickly to implement his economic reform agenda aimed at boosting growth and inflation. This included expansionary monetary policy, incorporating a doubling of Japan's monetary base and aggressive government bond purchases. Events in Japan were seen as significant because they represent a substantial injection of additional liquidity into the global financial system. However, from late May through to the end of June two other matters progressively dominated leading to a vicious selloff of risk assets, negatively impacting the rand and local assets. The first was increasing angst over China's growth prospects, with their central bank's bungling of a liquidity crunch adding to the concern. The second was concern about the US Fed's 'tapering', in reference to an anticipated reduction of the Federal Reserve's quantitative easing programme.

The US Federal Reserve has sought to boost its economy by purchasing bonds, thereby pushing bond yields down. Since April, some Fed officials have hinted at the possibility that the central bank could start tapering its monthly purchases. Fed Chairman, Ben Bernanke announced on 19 June that the Fed FOMC planned to start tapering its purchases from the fourth quarter of 2013 and end its purchases in mid-2014, contingent on continued positive economic data in the US.

Local data released over the last quarter confirmed that economic activity has remained weak in South Africa, while inflation has remained subdued. First quarter GDP numbers showed that the economy expanded at an annualised rate of 0.9% over that quarter, down from 2.1% recorded over the fourth quarter of 2012, with private domestic demand also recording weaker growth rates. Consumer inflation narrowed to 5.6% in May, from 5.9% in the three months to April. South Africa's current account deficit narrowed to an annualised R190.9bn (5.8% of GDP), from R212.6bn (6.5% of GDP) in the fourth quarter of 2012.

Leading into the May Monetary Policy Committee (MPC) meeting, local markets priced in a better than even chance that the repo rate would be cut either at that or subsequent meetings. This view was based in part on the expectation of ongoing weak growth and relatively benign inflation, a rand that continued to benefit from favourable risk appetite and a global policy environment that remained loose. The MPC left rates unchanged but left the door open for further easing as the post meeting interview stance was decidedly dovish. However, all prospects of further easing evaporated as the local market reacted in dramatic fashion to global events. Stop losses and the consequent risk reduction affected the entire yield curve. The heavy positioning by leveraged accounts, betting on the possibility of further easing, increased the severity of the selloff. This was not an isolated event; all emerging markets suffered the same fate.

Our base case expects policy rates to remain on hold, with the hiking cycle only commencing at the end of 2014. Consequently we see the recent selloff in rates as attractive investment opportunities. Currently we see particular value in the 9 and 12 month area of the money market curve. These instruments have priced in more interest hikes than our most pessimistic risk scenario suggests. As normality and liquidity returns to the market we expect the money market curve to flatten. We anticipate, however, that the market will remain volatile in the coming months as the market grapples with both the timing of the withdrawal of the unprecedented stimulus and the commencement of the domestic hiking cycle. Local price dynamics will be data driven and a heightened propensity to overreact will remain. Staying true to our macro view in such a challenging investment environment will offer opportunities to add assets to the fund that will enhance the return over the longer term.

Figures released in February showed that the economy grew at a faster-than-expected rate over the final quarter of 2012, but more detailed numbers in March showed that the demand-side of the economy continued to weaken. Gross Domestic Product (GDP) expanded at an annualised rate of 2.1% over the 4th quarter, up from 1.2% over the 3rd quarter. Growth was stronger due to better performances from manufacturing, transport and financial services, and less of a drag from mining.

Stats SA published South Africa's rebased and reweighted Consumer Price Index (CPI) in February. Recent figures showed that consumer inflation rose to 5.9% in February, from 5.4% in January. We see consumer inflation ticking higher over the next few months, with a peak around 6.5% in the 3rd quarter of 2013. Although we expect consumer inflation to slip below 6% by the 4th quarter of 2013, the back end of 2014 is likely to again see a breach of the 6% upper limit of the Reserve Bank's inflation target range. The above trajectory does not incorporate the rand's recent weakness, and the risk to the forecast is thus clearly on the upside.

The Reserve Bank's Monetary Policy Committee left the benchmark repo rate unchanged at 5% at its January and March meetings. This was despite successive deteriorations in the Bank's inflation outlook. The Bank sees inflation averaging 6.3% over the 3rd quarter of 2013. Growth is expected to average 2.7% and 3.7% in 2013 and 2014 respectively.

We think that the upside risks to inflation are quite serious. In this respect the rand, wages and food prices are bugbears to watch. We thus remain of the view that there is little prospect for further rate cuts. Our view remains that the next move in rates will be up, but we maintain that a hike will be delayed until the end of 2014 at the earliest. In the coming months we expect that the market will grapple with the timing of the 1st hike, which will lead to rates moving higher or lower on high frequency data. This will (and has already) offer us opportunities to invest into longer term fixed rate instruments at attractive rates as the market gets too hawkish and starts pricing in the hiking cycle too aggressively.

From calls for a collapse in Europe to warnings that US stocks would decline, Wall Street got little right in its prognosis for the year just ended, showing that investors failed to anticipate how government actions could influence markets. US stocks, as measured by the S&P 500 Index, closed the year up 13.41% and up 0.71% in December after Congress passed a bill averting most of the tax increases and spending cuts. Commodities rose and oil rallied to a three-month high. Bullion closed the year at $1 665 a troy ounce, up 5.86% for the year.

Locally equities were the best performing asset class in December, returning 3.15%, Inflation-linked bonds finished 2nd at 3.07%. Nominal bonds returned 2.3%, with cash posting a return of 0.43%.

Lackluster global demand was a major headwind for the South African economy in 2012, with domestic developments adding to what stacked up to be a disappointing economic performance. Economic activity slowed sharply through the 2nd half of the year, with the real economy growing by an annualised 1.2% over the 3rd quarter, after expanding by 3% over the 1st half of the year.

Consumer inflation was unchanged at 5.6% for the 2nd consecutive month in November. We expect consumer inflation to move broadly sideways through to the early part of 2013, with a gradual rising trend thereafter.

South Africa's economic outlook over the next year or two is not great. Growth is likely to remain subpar and inflation is likely to be more of a headache. While the global environment will continue to present a major headwind for domestic activity, much of the recent deterioration in the economic outlook has been self-inflicted. This presents the Reserve Bank with a challenge, in that a monetary policy response to such disruptions is ineffective. South Africa faces the added challenge of funding a widening current account deficit. In such an environment excessive stimulation of domestic demand to counter supply-side disruptions may end up being self-defeating.