Respite from the great repricing

November marked a turning of the tide

November marked a turning of the tide for the “Great Repricing” (as referred to by some) of developed market bonds. Notwithstanding the strong labour market, the sharp post-COVID ascent in US real rates was halted by continued evidence of cooling consumer price pressures and a watchful, data-dependent Federal Reserve Bank (Fed) which seems increasingly likely to have played its last act in this interest rate cycle when it hiked the upper-bound of the Federal Funds Target Rate to 5.5% in July. In the Eurozone, weak underlying macroeconomic growth conditions and cooling price pressures also strongly suggest that the 25 basis point (bps) increase in the Deposit Facility Rate in September to 4.0% marked the last in a cumulative 450bps interest rate hiking cycle.

Against this backdrop, the 10-year US Treasury Inflation-Protection Security (TIPS) yield retreated to a month-end closing yield of 2.09% from 2.52% at the end of October. Nominal rates in the US followed suit, with the generic 10-year nominal bond rate closing the month at 4.33%, 60bps lower than the October close. This bond market strength filtered through to the local rates, with the generic 10-year local currency bond yield retreating from 12.24% in October to 11.57% at the end of November.

Figure 1: 10-year constant maturity US and RSA nominal yield to maturity

Headline consumer prices threaten the upper bound of the target

Headline consumer price inflation (CPI) spiked to 5.9% year on year in October from 5.4% in September, owing mainly to higher food and fuel price increases on a year-on-year basis. The food price pressure was broad based, with all food categories recording month-on-month price increases. While some of the pressures underpinning the overshoot in food prices are already easing, the forecast risk remains elevated due to both the forecast El Niño weather pattern as well as continued irrigation challenges presented by unreliable electricity generation. Despite this threat to headline inflation, the moderation in core CPI in October to 4.4% year on year from 4.5% in September clearly reflects the weak underlying demand-pull pressure on inflation.

Against this setting, although the South Africa Reserve Bank (SARB) monetary policy committee (MPC) members unanimously voted to retain the repo rate at 8.25% in November, the accompanying policy statement remain decidedly hawkish. This is justified by inflation expectations that remain anchored above the mid-point of the 3% to 6% inflation target band as well as the upside forecast risk in the medium-term. Notwithstanding these risks, particularly those posed by loadshedding, fuel prices and the forecast El Niño weather pattern, we expect a prolonged pause in domestic interest rate cycle before a gradual cutting phase commences towards the middle of 2024.

The combination of a hawkish MPC (unlikely to cut interest rates quickly or materially) and relatively sticky headline consumer price inflation above the midpoint of the inflation target band in the months ahead will contribute to a continually elevated - and thus restrictive - real monetary policy rate in the medium term.

Inflation at the producer level also continues to edge higher from the recent 2.7% cyclical trough in year-on-year producer price inflation (PPI) of final manufactured goods. PPI increased by 5.8% on a year-on-year basis in October, also driven higher by food and fuel prices.

Figure 2: Domestic inflation has bounced up from the cyclical trough

Discretionary spend remains constrained

Real retail sales grew by 0.9% year on year in September, the first year-on-year increase since November 2022. The positive print masks the weak underlying data, with the positive outcome primarily attributable to strong sales in textiles, clothing, and footwear. Monthly private sector credit extension slowed to 3.9% year on year from 4.6% in September, further highlighting the strain on consumer discretionary spending. While these data prints have not been key determinants of monetary policy in this cycle, they highlight the weakness of aggregate demand in the domestic economy and will lend support to the arguments for monetary policy easing in 2024.

After a gravity-defying showing in the first half of the year, mining and manufacturing production data have also underwhelmed in recent months. Mining production contracted by 1.9% year on year in October, with manufacturing production contracting by 4.3%. Unreliable and insufficient electricity production has been a binding constraint on these sectors, as is the mounting logistics constraint from Transnet. The 1.6% year-on-year growth in electricity production in October breaks a 24-month streak in output declines and provides a ray of light for these struggling sectors which have increasingly relied on the self-generation of electricity.

Debt service costs crowd out productive fiscal expenditure

The tabling of the Medium-Term Budget Policy Statement (MTBPS) confirmed the expected slippage in fiscal estimates relative to those tabled by National Treasury in February. While these updated estimates now better reflect our own assessment of the likely fiscal path, the risk remains for further slippage in the outer years of the medium-term expenditure framework (MTEF). Moreover, we remain particularly concerned by the high debt service costs and their consequent crowding-out effect on growth-enhancing expenditure, as well as the spiraling demands of mismanaged state-owned enterprises (SOEs) on the fiscus.

Figure 3: Debt service costs and Real Gross Domestic Product (GDP)

Global rates lead a strong local bond market recover

Aided by the significant developed market yield compression in November, domestic bond yields ratcheted lower, unwinding some of the capital losses incurred in recent months. The IGOV index, comprised of sovereign issued local currency inflation-linked bonds (ILBs) rendered an extraordinary monthly return of 4.97%, outperforming the broader interest-bearing asset class. The ALBI Index returned a similarly abnormal 4.73%, led by the 5.90% return of the +12-year maturity segment. Cash, proxied by the SteFI Composite Index, was the worst performing interest-bearing sector in the month, rendering a return of 0.65%.

Figure 4: Bond market index returns (periods ending 31 November 2023)

/// THE TAKEOUT: November marked a turning of the tide for the Great Repricing, with developed market bond yields retracing from their recent peaks. This strength filtered through to the local rates, with the generic 10-year local currency bond yield retreating from 12.24% in October to 11.57% at the end of November. Domestic inflation (at both a consumer and producer level) notched higher in October, largely due to increasing fuel and food prices on a year-on-year basis. Against this setting, the SARB MPC remains decidedly hawkish and unwilling to openly concede that we are at the end of the monetary policy tightening cycle. We share the SARB’s concerns about the near-term upside risk to consumer prices but believe that the 8.25% repo rate marks the peak of the current interest rate cycle, with a prolonged pause to follow. From a government finance perspective, expenditure pressure and slowing corporate income tax receipts have contributed to the underperformance of fiscal metrics. While the MTBPS accounted for these realities, we believe the extent of fiscal slippage is still underestimated in the outer years of the MTEF.