Early in the fourth quarter of 2015, rhetoric from members of the Monetary Policy Committee (MPC) of the South African Reserve Bank had shifted towards the hawkish direction. In a speech delivered on the 5th of October, Governor Kganyago stated that "Permanent stimulus is not countercyclical. One of my greatest concerns is that we let the fear of slow growth scare us into a deeply uncomfortable macroeconomic position in which monetary policy accepts stagflation." Indeed, this rhetoric was followed with action in November, when the MPC increased the repurchase rate by 25 basis points. It was a widely held view that the hike was pre-emptive in nature and timed ahead of the policy rate increases in the United States.

Globally, the most pertinent event in Q4 was the Federal Reserve’s move away from the zero lower bound by indicating an increase in policy rates by 25 basis points. Having telegraphed the rate hike so well in advance, global markets expected and digested the move very well. The median policy rate from the Fed’s Survey of Economic Projections indicates a further 100 basis points of hikes for 2016 which is interpreted as "a hike every other meeting". Market expectations as inferred by Fed-funds futures prices, however, do not align with the SEP. These futures contracts indicate a mere 4.8% probability of an outcome in which the Fed Funds rate is above 1.25% after the final FOMC meeting of 2016. The manner in which these expectations converge over the year ahead will prove most instructive in the determination of asset prices.

Locally, the defining event of Q4 was the political bungling that resulted in three different South African Finance Ministers in the space of just four days. It was a series of events that shed much light on the sometimes intractable concepts of political stability and institutional strength. The unexplained dismissal of former Minister Nhlanhla Nene added weight to the perception that the fiscal conservatism that characterized his brief reign as Finance Minister did not have backing in the Presidency. While SA asset prices had, in the past, reacted quite negatively to the replacement of Trevor Manual in May 2009 and Pravin Gordhan in May 2014, the scale of the negative moves indicates that there were much larger concerns this time around. These concerns extended to both the mandate and independence of the SARB as market participants, cognisant of events in Turkey and Brazil, began to price in the worst. Indeed, too much bad news was priced in and markets reacted with a sigh of relief when Minister Gordhan was redeployed into his old seat. We read this "backtracking" as an example of a political system passing a crucial test by ejecting a Minister that was clearly rejected by both the intelligentsia and the financial markets.

South African data releases continued to indicate weak levels of economic activity. The economy grew by a disappointing 0.7% in the third quarter on a seasonally adjusted annualised basis. The Q3 fall of 4.9% in durable goods is an indication of retrenchment in interest-rate sensitive demand. While the Standard Bank PMI improved to 49.6 in November from 47.8 in October, the Barclays Manufacturing PMI plummeted to 43.3 from 48.5 over the same time period. The Manufacturing PMI does not bode well for the already beleaguered sector that saw production decline by 1.7% from September to October. Retail Sales data was encouraging with the October print at +3.3% year-on-year versus expectations of +2.5%. Another positive outcome was to be found in the Trade Balance for November that indicated a surplus of R 1.8 billion versus an expected deficit of R 6.6 billion.

Inflation outcomes continue to remain benign, albeit with a moderate rising trend. CPI and Core CPI printed at 4.8% and 5.1% respectively in November. Average inflation for the eleven months to November stood at 4.5% which is 1.5% below the 6% average that the MPC expected for 2015 when it began the hiking cycle in January of 2014. Since the hiking cycle began, hawkish policymakers have been concerned about pass-through from currency depreciation into local inflation. Thus far, pass through has been nowhere near the anticipated levels and the risk is that the damage inflicted on growth by constricting already deficient demand will result in ratings downgrades by the credit rating agencies who are primarily concerned about weak growth. In the event of further downgrades, the currency would be likely to weaken further, exacerbating the inflation risks. On analysis of the feedback loops, the troubling conclusion is that attempting to hike our way out of a "stagflationary" bind may only serve to perpetuate both rising inflation and weak GDP growth.

We hold the view that the MPC’s reaction function is clearly calibrated with hawkish parameters and driven by its inflation targeting mandate. Upside inflation risks continue to emanate from drought inflicted food prices and the lagged effects of exchange rate depreciation. As such, the risks to our view have increased and we are cognisant of the potential outcome where the SARB’s hiking cycle is not tempered by a weak economy. The heightened volatility in the exchange rate together with the recent marked depreciation could very well force the SARB into hiking by 50 bps at the January MPC as they continue to bang the drum of currency related inflation risks.

PERFORMANCE COMMENTARY

The fund has generated positive levels of income in excess of returns made available through deposits and call accounts offered by banks. Since inception the fund has outperformed its benchmark, whilst providing capital protection and liquidity for investors. The fund rarely experiences periods of underperformance but does ultimately have a long term emphasis. A long term view and capital losses can result in short term underperformance. However, the long term performance, net of fees, is indicative of the reduced downside risk that the fund offers.