Market review

In the second quarter, SA’s GDP grew by 3.1% year-on-year (y/y), recovering almost fully from the similar-sized dismal contraction in the first quarter. The factors responsible for the recovery were predominantly the opposite of those in the first quarter, namely recovery from a low base and the positive impact of reduced power cuts by Eskom on mining and manufacturing production.

Headline CPI inflation remained surprisingly low over the quarter, improving to 4.3% y/y in August, from 4.5% y/y in June. In July, it was even as low as 4% y/y, mainly as a result of lower fuel price inflation and also, surprisingly, lower electricity and food price inflation.

With inflation at lower levels, the South African Reserve Bank (SARB) cut the repo rate with 25 basis points (bps) at its July Monetary Policy Committee (MPC) meeting, from 6.75% to 6.50%, providing the economy with much-needed support.

At its September MPC meeting, the SARB kept the repo rate unchanged at 6.50%, following a unanimous vote. They are of the opinion that risks to the inflation outlook are balanced. Their 2019 inflation forecast was lowered to 4.2%, the 2020 forecast remained unchanged at 5.1%, and the 2021 forecast was increased slightly to 4.7% from 4.6%. They kept the 2019 growth forecast unchanged at 0.6%, lowered the 2020 forecast to 1.50% from 1.80%, and lowered the 2021 forecast to 1.80% from 2%. Speaking to Bloomberg earlier in the month, SARB Governor Lesetja Kganyago mentioned that the jump in GDP was from a low base, and consequently the SARB is not changing its 2019 growth forecast of 0.6%.

Eskom remains the biggest risk for the SA economy, which was reiterated again with the release of their FY2019 results, recording a R20.7 billion loss. Early in the quarter, Finance Minister Tito Mboweni tabled the Eskom Special Appropriations Bill, which provides for an additional R59 billion for this fiscal year and 2020/21. They also did not provide any information on the planned unbundling and reform. The Chief Restructuring Officer was only appointed at the end of July. This shows that they are struggling to come up with solutions on how to take the struggling parastatal forward. National Treasury also announced that they will increase its weekly SA government bond issuance by R1.51 billion, of which a substantial portion will be used to support Eskom.

At the Sub-Saharan Africa Summit, Moody’s stated that the chances of a downgrade in the next 12 to 18 months are small. According to them, worst-case fiscal metrics are a 70% debt-to-GDP ratio and a fiscal deficit of 7% of GDP, and the best case is a debt-to-GDP ratio of 65%, which is still similar to other BBB- rated countries at 60%. The Moody’s rating outlook is currently stable, but there is a good chance that it can be changed to negative. National Treasury recently issued US$5 billion worth of Eurobonds, which will help to reduce SA’s fiscal deficit significantly.

Government is close to finalising a programme for the redistribution of state-owned land. If implemented successfully, this will be positive for the economy, investors and rating agencies. President Cyril Ramaphosa also recently announced the appointment of an Economic Advisory Council, which will aid the government and presidency in the development and implementation of growth-boosting policies.

During the quarter the US Federal Reserve (Fed) cut interest rates twice by 25 bps. They stated that this is not necessarily the start of an extended rate-cutting cycle. They stated that this is not necessarily the start of an extended rate-cutting cycle. The objectives of the rate cuts are to insure their economy against downside risks from weak global growth and trade policy uncertainty, to help offset the effects that these factors currently have on the economy and to promote a faster return of inflation to their 2% target. The European Central Bank also cut their benchmark interest rate by 10 bps and restarted their stimulus programme, intending to buy €20 billion of bonds per month.

Core CPI remained unchanged at 4.3% y/y during the quarter. PPI inflation decreased from 5.8% y/y in June to 4.5% y/y in August. The Rand weakened to 15.17 against the US Dollar from 14.11 during the quarter. The 10-year SA government bond yield weakened to 8.92% from 8.69%. The trade balance increased from a surplus of R2.1 billion to one of R6.84 billion. The unemployment rate increased from 27.6% in the first quarter to 29% in the second quarter.

The money market yield curve shifted down after the 25-bps rate cut in July. After the September MPC meeting, where the SARB kept the repo rate unchanged, the curve steepened a little again. Now, with the SARB’s inflation expectations for 2020 and 2021 still being above the midpoint (4.5%) of the target range (3-6%), the market is only expecting one 25-bps rate cut over the next year.

What we did

All maturities were invested across the money market yield curve, exploiting the term premium as well as adding some higher-yielding fixed-term negotiable certificates of deposit (NCDs). Quality corporate credit, which traded above the three -month JIBAR rates, was added to the portfolio. We preferred a combination of floating rate notes in the portfolio together with some fixed-rate NCDs. The combination of corporate credit, high-yielding NCDs and floating rate notes will enhance portfolio returns.

Our strategy

Our preferred investments would be a combination of fixed-rate notes, floating rate notes and quality corporate credit to enhance returns in the portfolio. Although the curve steepened a little, fixed-rate notes are still not providing enough compensation for their additional interest rate risk compared to floating rate notes.

Market review

During a relatively uneventful first month of the quarter, the two biggest central banks in the world, namely the US Federal Reserve (Fed) and the European Central Bank (ECB), took centre stage.

First up was the ECB, which on the back of weakening economic conditions in the Euro Area decided to keep their short-term interest rates unchanged and that they will continue to reinvest maturing principal payments on securities, as well as maintain favourable liquidity conditions and an ample degree of monetary accommodation. Similarly, the Fed kept their rates unchanged at the end of the month, maintaining their ‘patient-flexible monetary stance’ in the context of slowing global growth. Overall these actions are supportive for emerging market countries like South Africa.

In the SA Reserve Bank (SARB)’s Monetary Policy Review (MPR), they emphasised that the current global economic conditions, with global growth slowing and rates easing, are considered thoroughly in their decisions and economic forecasts. They argue that SA’s potential growth rate is probably lower now, near long-term lows of 1.3% in 2019 and only 1.5% by 2021, with ‘state capture’ being largely responsible. With regards to longer-term inflation, they stated that it is now more converged towards the 4.5% mid-point of the target range.

One of the most important events this quarter was undoubtedly the National Elections. The ANC obtained 57.5% of the votes in the election, which was their worst result so far. This did not have ramifications for the markets, seeing that a lower result was expected.

At the SARB’s May Monetary Policy Committee meeting, they voted to keep the repo rate unchanged, with three members voting for no change and two voting for a 25- basis point cut. They stated that the risks to inflation are balanced now and they also reduced their forecast across the entire horizon. Considering that first-quarter highfrequency economic activity data point to negative GDP growth, together with the forecasts of analysts, a rate cut at the next few meetings seems more imminent now.

In the lead-up to the announcement of the new Cabinet, markets weakened somewhat, because of dissatisfaction with some potential Cabinet member selections and uncertainty with regards to a smaller Cabinet. The actual Cabinet announcement revealed the appointment of David Mabuza as deputy president, a reduction in ministerial appointments from 36 to 28 and the merger of various other positions. All this was interpreted positively by markets.

S&P left South Africa’s BB foreign currency and BB+ local currency sovereign credit ratings unchanged with a Stable Outlook. Unlike Moody’s, which decided to include Eskom’s government-guaranteed debt under the SA government debt, S&P decided to leave it separately. Moody’s stated that they did this because of the already large government support that Eskom receives for its operations and debt servicing. Globally, the trade wars continued to batter markets as President Trump decided to consider adding tariffs on European cars.

July featured the State of the Nation Address (SONA) where newly elected President Cyril Ramaphosa was expected to shed light on a number of important issues. The most critical among these issues was information regarding further financial and operational support for Eskom. First it was stated that the R23 billion provided this year will be enough for it to meet its obligations until October. Secondly, a large portion of the R230 billion support over the next ten years will be allocated earlier to allow Eskom to operate as a going concern for two years, during which time it must be unbundled into three separate state entities. Furthermore, a chief restructuring officer (CRO) will be appointed by mid-July. The CRO must produce a plan by end-2020 on how to restructure Eskom’s mounting debt, without any creditors being forced to take losses.

Other stated SONA objectives with less detail were goals to eliminate hunger, provide jobs for two million young people, improve educational outcomes and halve violent crimes over the next decade. On plans relating to kick-starting growth, he mentioned previous plans of rebuilding SA’s industries using the model of the motor vehicle industry and ‘master plans’ for clothing, textiles, gas, chemicals and plastics, renewable energy and metals.

First-quarter 2019 GDP surprised significantly to the downside, declining by 3.2% quarter-on-quarter (q/q), compared to consensus expectations of a decline of 1.7%q/q. This first-quarter contraction was the worst quarterly contraction since the global financial crisis in 2009. It mainly shows the effects of Eskom’s power cuts on the mining and manufacturing sectors. The International Monetary Fund remained cautiously optimistic about SA’s growth prospects, saying that longstanding growth impediments must be removed. Moody’s issued a statement saying that weak firstquarter 2019 growth is credit negative because it makes the government’s objective of lifting growth while consolidating its fiscal position more difficult. It also lowered its 2019 GDP forecast from 1.3% to 1%.

ANC Secretary-General Ace Magashule announced that the party had agreed to expand the SARB’s mandate to include growth and employment objectives, which was swiftly contradicted by Finance Minister Tito Mboweni. This uncertainty surrounding the SARB’s mandate continues to be a drag on investor and business sentiment. President Ramaphosa also later said that the ANC supports the SARB’s independence and that nationalisation of the central bank is ‘simply not prudent’.

Headline inflation in March and May was 4.5% year-on-year (y/y). Core CPI declined from 4.4% y/y in March to 4.1% y/y in May. PPI inflation increased from 6.2% y/y in March to 6.4% y/y in May. The Rand/US Dollar exchange rate strengthened to 14.11 from 14.42 during the quarter. The 10-year SA government bond strengthened to 8.69% from 9%. The trade balance decreased from a surplus of R5 billion to a surplus of R1.74 billion. The unemployment rate increased from 27.1% in the last quarter of 2018 to 27.6% in the first quarter of 2019.

The money market yield curve flattened significantly over the quarter as a consequence of persistent low inflation expectations and the struggling economy. The curve (market) is now pricing in about two 25-basis point rate cuts over the next year, compared to a neutral rates outlook three months ago.

What we did

All maturities were invested across the money market yield curve, exploiting the term premium as well as adding some higher-yielding fixed-term negotiable certificates of deposit (NCDs). Quality corporate credit, which traded above the three -month JIBAR rates, was added to the portfolio. We preferred a combination of floating rate notes in the portfolio, together with some fixed-rate NCDs. The combination of corporate credit, high-yielding NCDs and floating rate notes will enhance portfolio returns.

Our strategy

Our preferred investments would be a combination of fixed-rate notes, floating rate notes and quality corporate credit to enhance returns in the portfolio. With the money market curve flattening significantly over the quarter, fixed rates are even lower now. Accounting for one 25-basis point interest rate cut, floating rate notes still outperform fixed-rate notes.

Market review

Emerging markets got out of the starting blocks with significant speed, rallying substantially on the back of a ‘patient’ US central bank (the Federal Reserve), which indicated that it won’t be hasty with interest rate hikes and that it will also be flexible with regard to its bond holdings. The South African currency, money, bond and equity markets were all beneficiaries of the Federal Reserve (Fed)’s dovishness.

In February, the strong emerging markets rally, which occurred during January, started to fade, with South Africa following suit. Locally, however, fuel was added to the fire when South Africa’s vital electricity provider, Eskom, announced an increase in projected losses from R11 billion to R20 billion. This was exacerbated by the reinitiation of their load shedding procedures, which is a significant drag on the economy.

In President Cyril Ramaphosa’s State of the Nation Address (SONA), he continued to place the focus on catalysing the economy and encouraging investment, rehabilitating important institutions and fighting corruption. As a key outcome from the SONA, the market was looking for a clear message, stating how Eskom will be supported going forward. Speaking in parliament mid-month, Ramaphosa said that Eskom will not be privatised and that there will be no retrenchments. He also promised that Finance Minister Tito Mboweni will unveil Eskom’s government support package during his budget speech.

In Mboweni’s budget speech, he stated that government will support Eskom for three years to the tune of R23 billion per year. This will provide them with some control and conditionality on how the struggling institution will be managed and reformed. Overall, the budget sets out wider fiscal deficits going forward, with slight tax increases and bigger baseline expenditure cuts, which include some public sector compensation reduction measures. Ratings agency Moody’s issued a negative statement on the budget, stating that the Eskom bailout will lead to higher fiscal deficits and debt levels, while leaving contingent liabilities unchanged.

In the lead-up to the SA sovereign credit rating review by Moody’s at the end of the quarter, the SA Rand weakened substantially, especially when compared to the money and bond markets, which weakened to a lesser extent. Another factor leading to a weaker Rand was a stronger Dollar as a result of safe-haven US Treasury bond purchases, as US recession fears reared its ugly head indicated by an inverting Treasury yield curve.

Growth in 4Q2018 slowed to 1.4% quarter-on-quarter (q/q) from 2.6% q/q in 3Q2018. This decline was as a result of slower growth in the manufacturing and agricultural sectors. The unemployment rate declined to 27.1% in 4Q2018 from 27.5% in 3Q2018.

In March, the SA Reserve Bank’s Monetary Policy Committee voted unanimously to keep the repo rate on hold at 6.75%. They turned more dovish, stating that the risks to the inflation outlook are more or less evenly balanced, compared to the previous meeting where they said that the risks are moderately to the upside. They also said that they view the current monetary policy as accommodative, which means that they will not easily cut, especially considering that they are targeting inflation at 4.5%.

Moody’s refrained from giving an update of SA’s sovereign credit rating, leaving it at the lowest investment grade level with a Stable Outlook. Although SA’s fiscal position and Eskom have deteriorated substantially since the last rating change in 2017, Moody’s stated that SA’s credit scores were similar to those of other Baa3- rated countries. It also mentioned that the key risks to a rating downgrade are the continued increase in government debt and contingent liabilities from SOEs, and very low growth.

The Fed left interest rates unchanged at their March meeting, adjusted the number of forecast rate hikes (dot plot) this year to zero and said that they will end the drawdown of their bond holdings by September. They also reiterated the same monetary policy stance, stating that they will be patient amid global economic and financial developments and muted inflation pressures.

Headline inflation declined to 4.1% year-on-year (y/y) in February, from 4.5% y/y in December. Core CPI remained unchanged at 4.4% y/y during the quarter. PPI inflation declined to 4.7% y/y in February, from 5.2% y/y in December. The Rand weakened slightly against the US Dollar to 14.42 from 14.38. The 10-year SA government bond strengthened to 9% from 9.21%. The trade balance decreased from a surplus of R16.7 billion to one of R3.99 billion. The money market yield curve flattened a little over the quarter due to persistent lower inflation expectations.

What we did

All maturities were invested across the money market yield curve, exploiting the term premium as well as adding some higher yielding fixed-term negotiable certificates of deposit (NCDs). Quality corporate credit, which traded above the three -month JIBAR rates, was added to the portfolio. We preferred a combination of floating rate notes (FRNs) in the portfolio together with some fixed-rate NCDs. The combination of corporate credit, high yielding NCDs and FRNs will enhance portfolio returns.

Our strategy

Our preferred investments would be a combination of fixed-rate notes, FRNs and quality corporate credit to enhance returns in the portfolio. With the money market yield curve remaining roughly the same during the month, fixed-rate notes still do not provide enough compensation for their additional interest rate risk. Considering the above we still prefer FRNs to fixed-rate notes.