Geopolitics resets the macro narrative

Geopolitical risk spectacularly spilled over into energy and financial markets in February 2026, dominating the quarterly narrative and forcing a pivot in the market consensus from disinflationary optimism at the turn of the year to stagflation anxiety by the end of the first quarter.

The constructive investment backdrop that marked the second half of 2025 (meaningfully aided by the generally accommodative monetary policy stance of developed market central banks) was upended by the coordinated military attack by the US/Israel on Iran.

Retaliatory measures by Iran, including counter strikes on energy infrastructure in neighbouring gulf nations, and its effective blockade on the Strait of Hormuz - a chokepoint for an estimated 20% of global seaborne crude oil trade prior to the conflict - resulted in a spectacular surge in energy prices.

The energy shock doused market expectations of accommodative monetary policy by central banks, including the US Federal Reserve Bank (Fed) and European Central Bank (ECB), with a marked pivot from pricing a continued gradual cutting cycle at the start of the year, to potential interest rate hikes in 2026.

Unsurprisingly, monetary policy decisions by the major central banks aligned with these expectations in March, with the Fed and ECB both raising their 2026 inflation forecasts, reaffirming their commitment to their 2% inflation targets and their readiness to hike rates if the energy related inflation spike morphs into broader, persistent consumer price pressures.

The fine balance central bankers often need to strike between suppressing price pressures without forestalling economic growth will be acute for the Fed, given its dual mandate of maintaining price stability and pursuing full employment – more so given the political pressure heaped on outgoing Fed Chairman Jerome Powell and other Fed Governors by President Trump to stimulate monetary policy.

The Richard Nixon Presidency (1969–1974), and the pressure placed on then-Fed Chairman Arthur Burns to stimulate monetary policy, serves as a cautionary tale for safeguarding central bank independence.

Burns is remembered for unduly ceding Nixon’s wishes for accommodative monetary policy measures in the early 1970s despite simmering inflation pressures and relatively full employment, which ultimately resulted in runaway consumer price inflation for much of the next decade.

Domestic resilience is tested by external headwinds

South Africa reaped the benefits of its reform efforts in 2025, evidenced by its removal from the FATF Grey List, a sovereign credit rating upgrade by S&P Global, stabilising fiscal accounts, and the anchoring of inflation expectations towards the South African Reserve Bank (SARB)’s revised 3% inflation target midpoint.

However, the geopolitical shock in the Middle East has naturally spilled over to the local market and threatens to stem the positive local narrative and market momentum.

For now, the energy shock primarily threatens domestic inflation dynamics, but this dynamic may shift, contingent on the ultimate duration and severity of the conflict. The SARB held the repo rate steady at 6.75% in a split call between voting members in January, but turned decidedly hawkish at its March meeting, raising its inflation forecast for 2026 to reflect oil price dynamics.

An elevated real repo rate prior to the conflict gives the SARB room to assess the impacts of the ongoing conflict on inflation expectations, with evidence of second-round inflation effects a key watchpoint for guiding monetary policy moves in the near-term.

The R3/litre fuel levy reduction granted by National Treasury provided some immediate relief to consumers and will marginally temper the rise in energy prices in the coming months.

This measure will cost the fiscus between R6 and R8 billion in April and will likely taper off for the two months thereafter, as National Treasury gradually withdraws the support. We deem the support appropriate on a short horizon, and the cost bearable from a fiscal perspective.

In the near term, the Middle East conflict will continue to dominate market direction and monetary policy expectations. For now, from a financial market perspective, the costs have come to bear on energy prices, inflation expectations and monetary policy guidance, but growth and fiscal effects might soon follow, contingent on the duration and ultimate severity of the conflict.

Bonds surrender gains amid stagflation concerns

Local currency sovereign yield curves shifted materially higher in the quarter, with nominal yields adjusting in a parallel fashion, in lockstep with the repricing of monetary policy expectations, given the ongoing Middle East conflict, and the real yield curve bear steepened.

Against this backdrop, the JSE All Bond Index returned -3.36% in the quarter and IGOV returned -1.30%, unwinding some of the exceptional performance enjoyed by the interest-bearing asset class in the past year. Cash, proxied by the STeFI Call Deposit Index, returned 1.60% over the quarter, while the IGOV Index, which comprises sovereign-issued, local currency inflation-linked bonds, returned 8.33%.