At the September meeting, the Monetary Policy Committee [MPC] of the South African Reserve Bank kept the Repo Rate on hold at 5%, but left the door open for further stimulus if global growth fails to improve. The dovish stance of the MPC can be seen in its emphasis on the risks to the growth outlook, which remain "somewhat on the downside". Marcus stated that domestic growth remains constrained by the weak global economy, exacerbated by the loss of mining production following recent strike action in the mining sector.

On the SA macro front, blows to sentiment came from a lower-than-expected 02 GDP print and the current account of the balance of payments which was much higher than expected. The month culminated in a one-notch downgrade by Moody's of SA's country rating. On the positive side, it seems that global conditions remain supportive of continued capital account support for SA, indicating broadly unchanged fiscal and monetary policy settings.

Inflation ticked down over the quarter from 5.5% to 5%. Administered prices and transport continue to rise above the MPC's target band, and this, along with food prices, poses some upside risk to the inflation outlook. The SARB's inflation outlook remains within the target band after being revised to average 5.3% for 042012, and 5.2% for 2012. Core inflation remained flat over the quarter at 4.6%, and is expected to peak at 4.9% in 04 2012. 03 of 2012 saw a spike in the price of Brent Crude. The USD oil price rose 17% in the three months to end-September, and the Rand depreciated 2% vs the USD; hence the increase of 21 c/litre in the price of fuel for October.

3-month Jibar remained fairly flat over the quarter. At the end of September, the Forward Rate Agreements (FRA's) were pricing in a 35% chance of a rate cut early next year. The Fund maintains its short duration position, but will look for opportunities in the FRA curve. The Fund holds a mix of bank floating rate notes, bank step-up notes and inflation-linked bonds. Credit exposure remains conservative, primarily with the big four banks and State Owned Enterprises. Credit enhances the yield of the portfolio while inflation-linked notes are attractive in a rising inflation environment. bonds. Credit exposure remains conservative, primarily with the big four banks and State Owned Enterprises. Credit enhances the yield of the portfolio while inflation-linked notes are attractive in a rising inflation environment.
The Fund outperformed its benchmark over the month, due to it's exposure to a mixture of yield-enhancing assets.

In the past quarter, market indicators have delivered mixed signals of an economic recovery. Moderating inflation pressures, improving consumer confidence, declining insolvencies and a strengthening trajectory in real bank lending growth, are all encouraging signals. The latest Purchasing Managers Index [PMI] has shown moderation, the June number printing below the 50 level. We have also seen an uptick in the unemployment numbers, with the rate at 25.2% for 01 2012, up from 23.9% in 04 2011.

Inflation ticked down for the quarter dropping below 6% for the first time since September 2011. CPI ticked down from 6% to 5.7% for the quarter, while core inflation remained flat at 4.4%. Lower commodity prices and global food prices were the main drivers of the lower inflation over the last three months, and with headline inflation expected to remain within the target band for most of the remainder of 2012. PPI also ticked down for the quarter from 7.2% to 6.6%.
The current account deficit widened over the quarter to 4.9% of GDP. This was largely due to export growth declining on the back of weaker global economic activity. The deficit continues to be funded by foreign capital inflows due to SA offering attractive yields relative to the other markets. Any risk aversion to SA or global bonds in general, at a time when SA has a current account deficit, will have major consequences for the Rand and domestic inflation.

The price of Brent Crude fell 27.6% in US dollar terms for the quarter, falling from $123 at the beginning of April 2012 to $97 at the end of June. This resulted in fuel prices dropping 55c in June and expected to drop a further 85c in July. The Rand weakened 6.2% over the quarter against the USD.

The FRA curve shifted down post the dovish MPC meeting. The FRA's have shifted from pricing in flat rates for the next 12 months, to pricing in a 45% chance of a 50bp rate cut towards the end of the year. Interest rate hike expectations have been pushed out from 03 2013 to 02 2014.

With the FRA curve pricing in interest rate cuts, fixed rate assets are not offering much value, hence the Fund continues to invest in short duration floating rate paper. The Fund holds a mix of bank floating rate notes and bank step-up notes. Credit exposure remains conservative and largely sits with the big four banks. We continue to look for yield pick-up in credit and other sweeteners without taking on much duration risk.

The Monetary Policy Committee (MPC) of the South African Reserve Bank (SARB) kept its policy rate unchanged at 5.5%, which was in line with market expectations. The tone of the statement was somewhat surprisingly dovish, as Governor Marcus continued to paint a mixed picture of the SA economy at present, with the persistent risks to local growth seemingly overriding the on-going risks to the inflation outlook.

With headline inflation ending the quarter flat at 6.1 %, the SARB seemed to be comfortable in its vindication that inflation would decline in 2012. The Bank also intimated that inflation pressures are still of a cost push nature, hence the dovish tone of the statement. Despite inflation becoming more broad based in nature, Producer Price Inflation seemingly supported the Bank's dovish outlook, declining from 9.8% to 8.3% over the quarter. Core inflation, which has been benign in the past, ticked up over the quarter from 3.9% to 4.3%.

Food and energy prices remain an important driver of inflation and these factors represent the principal upside risks to inflation into 2012. Q1 2012 has seen the Rand strengthen versus the greenback, the Rand appreciating from R8.07 to R7.66, a movement of 5.04%. The price of Brent Crude ticked up over the quarter from USD107 to USD123, posing further upside risk to the inflation outlook.

Growth in Private sector credit extension (PSCE) ticked up from 6.1 % to 7.9% over the quarter, representing its highest growth rate since April 2009. This indicated marginal improvement in the real economy but it is still off levels that might require monetary policy intervention. Growth in mortgage advancements remains soft.


At the end of March 2012, the Forward Rate Agreements (FRAs) were pricing in flat rates for the year ahead, with rates expected to tick up in 12 months' time. 3-Month Jibar remained flat at 5.60%, and credit and funding spreads were also unchanged.

With the FRA curve flat, there is not much value or yield pick-up available on the curve at the moment, which means that we have to look for other sources of alpha such as sweeteners or credit. At this point, the Fund continues to maintain its short duration position. Credit exposure has been increased, but only in selected quality issues where higher yields could be locked in. We continue to look for yield pick-up in credit and other sweeteners without taking on much duration risk.

Over the quarter, mixed developments in growth and inflation both domestically and abroad, resulted in the South African Reserve Bank (SARB) leaving the repo rate unchanged at 5.5%. The balance of risks (i.e. growth versus inflation) has shifted from being "delicately balanced" at September's meeting to "upside inflation risk" at the November meeting.

Since September, inflation has ticked up from 5.7% to 6.1%, breaching the upper level of the SARB's inflation target of 6%. Food inflation was the main driver, which accelerated from 8.7% to 11.1% over the quarter. However, core inflation remained contained at 3.9%, which should give the SARB some comfort. Producer price inflation (PPI) on the other hand contracted slightly over the quarter from 10.5% to 10.1%, driven by lower electricity prices.

We have seen a mix of both positive and negative economic data over the past quarter. Retail and vehicle sales remained fairly robust. Private sector credit extension (PSCE) ticked up from 5.4% to 6.2%, mainly driven by low interest rates and improving household balance sheets. The Purchasers Managers Index (PMI) climbed above the 50 level to 51.6, which indicates a modest recovery in growth. Manufacturing production however dropped from 5.9% to 1%, a clear indication that the manufacturing sector is under pressure.

At the end of Q3 2011, the Forward Rate Agreements (FRAs) were pricing in rate cuts of around 20bps. The FRAs moved up slightly over the last quarter and are currently pricing in flat rates over the next year, with the first rate hike coming through in the Q1 2013. 3-Month Jibar climbed marginally from 5.58% to 5.60% and 1-year money market rates increased by 25bps. Credit and funding spreads ticked up marginally over the quarter.

With the FRA curve shifting higher, we will be looking for opportunities to lock in higher yields as we see opportunities. At this point, the Fund continues to maintain its short duration position. Credit exposure has been increased, but remains conservative in selected issues where higher yields could be locked in. We continue to look for yield pick-up in credit and other sweeteners without taking on much duration risk.