Market review and fund performance
Money market yields sold off aggressively during the second quarter with one-year negotiable certificates of deposits (NCDs) kicking up 1.56% over the period. The sell-off was led by the long end of the curve, causing the yield curve to steepen by a further 0.50%.

The second quarter was marred by concerns over rising global inflation and slower growth with further evidence in both developed and emerging market economies of a deteriorating outlook. Domestically the picture was no different, with both the food and fuel components of the inflation data continuing to surprise to the upside. Accelerating food and oil prices as well as increases in the electricity tariff are fuelling price hikes in the broader economy. During the quarter the market expected the South African Reserve Bank (SARB) to hike rates aggressively, which resulted in yields moving significantly higher. The SARB showed its commitment to fight inflation by hiking rates by 0.50% at both the April and June monetary policy committee (MPC) meetings. Cumulatively, the SARB has now hiked rates by 5% since the start of the interest rate cycle. The market had expected a 1% hike at the June meeting and initially rallied sharply in response to the 0.50% hike announcement. However, worse-than-expected inflation data and further hawkish comments by the Reserve Bank governor caused the market to once again price in further interest rate hikes.

Cash, as measured by the STeFI Index, returned 2.7% over the quarter, while the All Bond Index returned a negative 4.9%. The Investec Money Market Fund returned 2.7% over the quarter, in line with the STeFI 3-month Index.

Market outlook and portfolio positioning

Domestic activity data continues to show evidence of a slowdown in the economy with the Investec Purchasing Managers Index (PMI) contracting to 43.8 from a previous level of 49.1 and vehicle sales running at a negative 21.9% (on a year-on-year basis). We continue to remain concerned about inflation in the shorter term, with inflation peaking close to 12.5%. Our cautious approach during the quarter meant that we were well positioned for the sell-off. Going forward, with yields having moved substantially higher, we believe that the market is now more fairly valued. We will look for opportunities to take the portfolio longer into weakness.

Market review and fund performance
Internationally, global credit and financial concerns continued with the bail out of Bear Stearns. In an attempt to restore confidence, the US Federal Reserve (the Fed) cut the discount rate (the rate at which member banks can borrow from the Fed) by 0.25% and extended the term of borrowing from 30 to 90 days. In addition, the Fed relaxed collateral requirements, accepting investment grade corporate securities as eligible collateral, along with mortgage-backed, municipal and asset-backed securities. The Fed also introduced a new discount window facility for primary dealers, inclusive of nonbanks. At the 18 March federal open market committee (FOMC) meeting, the federal funds rate was cut by a further 0.75% to 2.25%. Domestically, money market yields sold off aggressively driven by the long end of the yield curve, causing substantial yield curve steepening during the quarter. Over this period the 12 month Jibar kicked up 0.35%, while two year NCDs were up 0.56%, causing the yield curve to steepen by 0.44% between the three month and two year points.

Cash returned 2.6% over the quarter as measured by the STeFI Index. The Investec Money Market Fund returned 2.6%, while the STeFI 3-month Index delivered a return of 2.7%. The All Bond Index returned a negative 1.9% over the period.

Market outlook and portfolio positioning
It will be a close call on whether the South African Reserve Bank (SARB) hikes interest rates at the 10 April monetary policy committee (MPC) meeting. Activity data is certainly showing a slowdown of the consumer with vehicle sales now running at a negative 17.5% year on year. The Purchasing Managers Index paints a picture of a weaker real economy with manufacturing contracting at the fastest pace since June 2003. The SARB is likely to watch inflation expectations closely for any signs of deterioration.

Inflation remains a concern and we see it peaking close to 10%. The rand continues to be vulnerable in the current global environment and we believe the risks to money market rates remain skewed to the upside. We were cautious during the month, allowing the duration of the portfolio to fall and invested mainly in the shorter end of the yield curve.

Market review and fund performance

Liquidity injections by central banks started to have an impact on tight global money market conditions during the fourth quarter, with three month inter bank rates falling from elevated levels. Central banks in the US, UK Canada, Switzerland and Euro region injected liquidity into global money markets in the largest coordinated action since 11 September 2001. The prompt reaction of the US Federal Reserve (the Fed) in cutting rates also helped to improve liquidity. The Fed cut rates at the last three meetings since September with the federal funds rate a full 1% lower at 4.25%.

Domestically, money market rates sold off aggressively with 12-month negotiable certificates of deposits (NCDs) kicking up just over 1% during the quarter. The South African Reserve Bank (SARB) hiked rates at both the October and December monetary policy committee (MPC) meetings. The SARB hiked interest rates by a total of 4% since the start of the interest rate cycle, taking the repo rate to the current 11%. In the question and answer session after the MPC meeting the SARB indicated that we may have reached the peak in the interest rate cycle. However, we believe that worse than expected CPIX data released towards the end of the month and higher food and oil prices skew the risks to the upside.

Over the quarter cash (as measured by the STeFI Index) earned a return of 2.5%. The Investec Money Market Fund also returned 2.5%, in line with the benchmark. The All Bond Index gave a return of 0.9% over the quarter.

Market outlook and portfolio positioning
The upward pressure in CPIX came mainly from food with both processed and unprocessed foods up sharply. We revised our inflation forecasts slightly higher on the back of food and oil continuing to surprise to the upside. Our view on inflation remains more bearish than the SARB and we see inflation peaking well above the 8% level. The political environment is further cause for concern. In the shorter term, lack of clarity on future policy coupled with tensions between government and the ANC NEC may contribute to an uncertain outlook for 2008 on the political front. Although we believe the money market is reasonably valued, risks remain to the upside and in the shorter term we continue to be slightly cautious, preferring the shorter end of the yield curve.