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Central banks are gearing up for hiking cycles

31 Dec 2021

Wikus Furstenberg, Rhandzo Mukansi, Yunus January, Daphne Botha, Aidan Kilian / Interest Rate Team

Economic & bond market review

With inflation persisting at multi-decade highs during the fourth quarter of 2021 in both developed and emerging market economies, central banks had very little choice but to start singing from their respective monetary tightening hymn books.

Although the tightening crescendo is yet to be reached, the US Federal Reserve has taken to doubling the pace of tapering to $30 billion per month, which puts it on course to end its $120 billion monthly asset purchases by the end of the first quarter in 2022. Slightly ahead of the curve, the Bank of England hiked rates in December from 0.1% to 0.25%, as annual inflation hit a 10-year high of 5.1% in November. Central Banks will have to navigate the tricky terrain with regards to the aggressiveness of their hiking cycles in 2022, given the higher likelihood of an improving inflationary backdrop due to the high base effects of 2021 and the possibility of supply chain normalisation.

Domestically, the South African Reserve Bank (SARB) Monetary Policy Committee (MPC) hiked the repo rate by 25 basis points for the first time since 2018, after having cut the rate by a cumulative 300 basis points since the beginning of the COVID-19 pandemic. The decision to increase the repo rate was split 3-2 on the five-person MPC, with the SARB citing concerns around short-term externally driven inflationary pressure contributing to the decision to gradually increase short-term rates.

Figure 1: Central banks are largely in tightening mode as inflationary pressures start peaking globallytral bank policy rate changes versus inflation

Source: Bloomberg, Futuregrowth

Uneven and uncertain global growth recovery will continue

As developed market central banks gear up for tightening cycles, Chinese monetary authorities have been moving in the opposite direction, with the Chinese central bank - the Peoples Bank of China (PBoC) - recently announcing a 50-basis point cut in the reserve ratio requirement. Despite an accommodative monetary environment, the Chinese recovery is showing signs of weakness, as issues such as limited credit growth and power supply constraints continue to provide headwinds to higher Gross Domestic Product (GDP) growth. Concerns around the recent default of Chinese real estate developer Evergrande and other indebted Chinese property companies have heightened fears around possible contagion of other emerging markets. In addition to the ongoing threat of various Coronavirus variants, the implications of a weaker Chinese economy, especially for emerging markets with close linkages, sets the scene for a continued uneven and uncertain global recovery.

Rating reprieve drives SA bond rally

Fitch Ratings became the first of the major rating agencies to upgrade their outlook on South Africa during the past quarter. Although SA’s foreign and local-currency rating remains three notches below investment grade at BB-, the outlook has been revised from negative to stable. The rating agency cited a more robust economic recovery and strong fiscal performance as key drivers behind the outlook change. This was largely due to South Africa’s positive terms of trade, which continue to be a boon to the fiscus, primarily in the form of exceptional gains in corporate income tax revenue, together with the fact the South Africa’s nominal GDP level was revised upwards by 11% during September. This had the impact of lowering key fiscal metrics such as the gross debt to GDP ratio. The news triggered a local bond market rally and helped bonds end the year on a strong note. This was after having endured a somewhat volatile quarter characterised by contagion from Turkey’s central bank decision to cut interest rates despite sky-high inflation and the emergence of the OMICRON COVID-19 variant, which triggered a flurry of travel restrictions aimed at Southern Africa.

Domestic inflation remains stubbornly high

Domestic headline inflation spiked to 5.5% in November, rendering it the highest point this far in the calendar year and the highest reading in just over four years. The transport category was primarily responsible for the strong pickup in inflation, as elevated rand oil prices drove an appreciation in petrol pump prices which are now approximately 34.5% higher than they were a year ago. The transport category contributed to 2.1% to the overall 5.5% increase in headline inflation. This helps explain the variance between headline and core inflation, in which the latter peaked at a rate of 3.3% in November. Although inflationary pressures persist in the form of supply-side induced price increases, underlying demand-driven inflation continues to remain soft, in light of a relatively high domestic unemployment rate and a constrained consumer.

This is in contrast with the global outlook, where tightening labour markets and narrowing output gaps are likely to feature strongly in monetary policy decision making going forward. Central banks find themselves in an unenviable position of having to forecast an unpredictable and largely uneven COVID-dictated global recovery, as they attempt to mitigate the effects of elevated, exogenously driven, supply-sided inflation.

Figure 2: Elevated inflation rates

Source: Bloomberg, Futuregrowth

Inflation-linked bonds ended the year on a strong note

The above inflationary developments triggered renewed demand for inflation protection, helping inflation-linked bond yields to drift lower over the period. The limited foreign ownership of inflation-linked bonds could explain why this asset class - unlike its nominal counterpart - tends to be less susceptible to sudden changes in global risk sentiment. The FTSE JSE Government Inflation-linked Bond Index (IGOV) thus rendered a strong return of 5.25% over the quarter, of which 4.66% was attained during December. Similarly, nominal bond yields trended lower in December, resulting in the FTSE JSE All Bond Index (ALBI) rendering a return of 2.69% for the month and contributing to the bulk of the quarter’s 2.87% return. Cash returns were marginally higher this quarter, following the Reserve Bank’s 25-basis points rate hike. The SteFI index rendered a return of 0.89% over the quarter. On an annual basis, inflation-linked bonds were the better performing asset class, with the IGOV rendering a 15.67% return. Nominal bonds managed to eke out a return of 8.26% over the calendar year; and cash was in last place, with an annual return of just 3.53%.

Figure 3: Bond market index returns (periods ending 31 December 2021)

Source: Bloomberg, Futuregrowth


A strong shift towards a tightening monetary regime was adopted by most central banks over the period, as the narrative around inflationary pressure shifted from being transitory towards being persistent. The SARB hiked the repo rate by 25 basis points during its most recent MPC meeting, citing an increase in externally driven inflationary pressure as the reason to pre-emptively dampen price pressures. Despite inflation reaching 5.5% during November, the local bond market ended the year strongly. Contagion concerns emanating from monetary policy error in Turkey and concerns around the highly-leveraged Chinese property sector were not enough to offset the positive impact of the unexpected Fitch ratings reprieve on the bond market. Fitch upgraded South Africa’s sovereign ratings outlook from negative to stable, as a result of an improved fiscal outlook. Having said that, global risk sentiment continues to seesaw as newer and potentially more severe variants of the coronavirus come to the fore. This continues to exacerbate concerns around the global recovery and tends to trigger bouts of risk-off sentiment. All considered, inflation-linked bonds delivered strong returns on both a quarterly and annual basis, as concerns around inflation and the need for inflation protection drove real yields lower. Nominal bonds were harder hit by the risk-off sentiment and inflationary concerns, but still managed to deliver decent returns over both the quarter and the year.

Key economic indicators and forecasts (annual averages)


    2017 2018 2019 2020 2021 2022
Gobal GDP   3.5% 3.2% 2.6% -3.6% 5.6% 3.9%
SA GDP   1.2% 1.5% 0.1% -6.4% 5.4% 2.3%
SA Headline CPI   5.3% 4.6% 4.1% 3.3% 4.4% 4.5%
SA Current Account (% of GDP)   -2.4% -3.0% -2.6% 2.0% 3.7% 0.2%

Source: Old Mutual Investment Group