The third quarter has seen the South African Reserve Bank (SARB) holding back on monetary policy easing as opposed to the second quarter where we saw the SARB on a path of aggressive rate cuts, cutting rates by 50 basis points (bps) versus 200 bps.
Money market rates increased across the board following the SARB’s decision to leave the repo rate unchanged at the September MPC meeting. The MPC’s decision was largely due to the fact that time is needed to assess the impact of the August rate cut.

Inflation continued its downward trend this quarter. CPI inflation ended the month at 6.4% y-o-y from 8.0% y-o-y the previous quarter. PPI deflation continued in August and another y-o-y decline in Money Supply growth illustrates that South Africa is lagging the global upswing in economic activity. Liquidity remains fairly tight in the economy. The decline in PSCE growth indicates that SMEs and corporates continue to be under strain as banks look to maintain tight lending criteria. However, credit extension to households appears to have bottomed out and vehicle sales have turned the corner. South Africa’s trade balance slipped back into the red in August (after three consecutive months of surpluses) on theback of ailing exports largely as a result of a strong rand. Though negative for the export sector, the rand’s strength should help exert a further downward pressure on imported inflation. There is an increasing probability that the rand’s strength, coupled with weak demand conditions, could drive inflation below 6% by year end, before picking up in December due to base effects.
PMI figures, in line with latest economic data, suggest that the manufacturing sector is likely to record positive growth forinthird quarter of this year.

The fund continues to outperform the benchmark STeFI Composite and is exposed largely to banks (90% in September), while 10% of the fund is in Government securities or short-term corporate debt.

The latest SARB MPC decision certainly suggests that we may yet be at or close to the bottom of the rate cycle. The shape of the yield curve suggests flat rates in the short term with rates rising towards mid 2010. The fund will maintain its high exposure

There are tentative signs the global economy is stabilising as seen in the latest PMI indicators, albeit over the past month we have seen retraction in the equity markets as well as a widening in credit spreads. Risk aversion towards emerging markets has improved and market confidence is getting better, although still fragile. It is clear the road to recovery is going to be a slow and rutted one.

On the local front, a collapse in global industrial production and trade has pushed the South African economy into a recession. South Africa's GDP figure for Q1 2009 came in at -6.4% and is expected to contract in the second quarter as well -but at a lesser amount. Positive growth is expected towards year end although the recovery is expected to be mild. SA is not a savings nation; hence we will likely see a heavier emphasis on inflation targeting by the South African Reserve Bank (SARB) in the not-too-distant future. The return to positive economic growth will depend on the global recovery.

On a positive note, South Africa recorded a R2 billion surplus in May from a deficit of R1.5 billion in April, while economists had forecast a deficit of R2 billion. The market reacted favourably with the currency strengthening to R7.70 against the US dollar.

With inflation decreasing, the second quarter saw the SARB continuing on its path of aggressive rate cuts with the April and May MPC meetings -a combined reduction of 200 basis points in the repo rate. There was no change at the June MPC meeting with the MPC's view that they "had done quite enough" (from a rates perspective) for now.

Inflation continued its downward trend this quarter. PPI deflation occurred in May and at 3% y-o-y, this is the largest on record. The last time SA experienced PPI deflation was in October 2003! CPI inflation ended Q2 at 8% y-o-y from 8.40% the previous quarter.

Credit figures also continue downhill. The dramatic decline in credit figures alludes to strain in households and corporates. The lag between interest rates and demand implies that there will be no dramatic recovery in credit in the short term.

The fund continues to outperform the benchmark STeFI Composite. The fund is exposed largely to banks (88% in June) while 12% of the fund is in Government securities or short-term corporate debt.
The market appears to have already discounted the bottoming of the yield curve with the shape of the curve showing rising rates towards the mid 2010. As a result, the strategy will be to increase investment in floating rate assets.

The quarter started on a volatile footing internationally with fears regarding the extent of the global economic slowdown as well as concerns over the massive amounts of liquidity injections and debt nationalisation that took place. On the local front, So uth African banks remain strong, having been cushioned to some degree from the global credit crisis. However, growth and lack of liquidity in the market will continue to come under pressure due to the global economic slowdown.

Economic growth in South Africa has come under immense pressure as a direct result of the worldwide economic slowdown. Hence, monetary policy over the past quarter was more dictated on concerns about the real economy and economic growth rather than inflation being slightly over its target.

The highlight this past quarter has definitely been the considerable drop in money market rates across the board. The repo rate was slashed by 200 basis points while inflation and its outlook improved significantly due to the slow down in demand for goods and credit and the re-weighting and re-basing of the inflation index.

Although the turmoil on the international front in terms of the global credit crisis appears to have subdued, the local curre ncy remained volatile as investors remain cautious and risk averse.

The trade deficit declined dramatically for the month of February, slipping to R571 million from R17.4 billion in January. The result of this was positive for the rand, which appreciated to R9.51 to the US dollar from R10.06 at the end of February 2009. However, this decrease is not viewed as sustainable and the financing of the deficit will continue to be of concern for the market in this current unfavourable economic period.

The fund continues to be exposed largely to banks (84% in March) while 16% of the fund is in Government securities or short - term corporate debt.

The expectation of further interest rate cuts sooner rather than later, due to the increased frequency of MPC meetings, have resulted in money market rates falling further across the board; and positive inflation data and poor economic growth, have contributed to the general consensus that rates are to fall even further. The emphasis will be to lengthen the duration in th e fund over the short-term.

This past quarter, investors faced vast volatility as recessionary fears and lack of confidence in the banking sector continued to take its toll. There was substantial destruction in value in stock markets around the world during this period. We have witnessed global risk aversion and South Africa's current account deficit put strain on the local currency, which resulted in the rand depreciating even further. However, as the year end approached, the turmoil on the international front in terms of the global credit crisis appeared to have subdued. And the rand clawed back some of its losses earlier in the quarter.

The December Monetary Policy Committee (MPC) meeting saw the much anticipated rate cut cycle finally come to pass with the Repo rate cut by 50 basis points. Year -on-year inflation figures eased for the third consecutive month. Economists predict a further reduction in inflation in the coming months as factors such as the re -weighting and re-basing of the inflation index and lower fuel prices come into play. This positive view on inflation certainly influenced the MPC's decision to lower rates.

Money market rates, especially the longer term, dropped considerably following the latest Repo rate cut. Further rate cuts are anticipated at the next few MPC meetings, with the size of these cuts debatable.

The country's trade deficit came in higher than the market expected. Imports decreased but exports declined at a more rapid rate. The financing of the deficit will continue to be of concern for the market in this current unfavourable economic period . However, the main goals of the authorities seem to be on stimulating growth and preventing a downturn.

The fund has mostly maintained its short-term re-pricing strategy and continues to outperform the benchmark.

The fund continues to be exposed largely to banks (81% at the end of the fourth quarter) while 19% of the fund is in Government securities or short-term corporate debt.

The rate cut in December signalled the change in the rate cycle. Further rate cuts are expected at the next few MPC meetings especially with inflation seemingly under control and growth under pressure. The emphasis will be to lengthen the duration in the fund over the short-term.