Tariff turbulence and the GNU fallout

The death of trade liberalisation 

Liberation Day, marked by the punitive “reciprocal” tariffs unleashed by the US on its international trade partners, has abruptly upended a century of globalisation and trade liberalisation. The rejection of incumbency in voter patterns in national elections in 2024 was always going to spill over into disruptive policy initiatives, but their limits were always estimated by a perceived sensitivity to market dynamics by the Trump administration, and a desire to preserve the life of the current economic expansion. These assumptions have been shattered, judging by the aggressive market response to the Liberation Day tariffs, and the subsequent revision in US growth and interest rate expectations for 2025.  

While the Trump administration hit the ground running in pursuit of its Make America Great Again (MAGA) objectives, with the US President issuing a raft of executive orders and policy initiatives, none have been as far-reaching as his international trade policy. The aim is to invigorate a “golden age” of elevated, non-inflationary economic growth by protecting American trade and industry. This policy path will be pursued alongside the deportation of millions of immigrants from the US, easing tax policy, and halving the fiscal deficit – a mix of incompatible objectives. Market participants are now wiser to these contradictions, but this awareness has come at the expense of market confidence and certainty, the bedrocks of spending and investing.  

The expected imposition of US tariffs led to a clear front-running of import orders in recent months. However, the fluidity in trade policy, which has spilled over into expectations that tariffs will be repealed (to some extent) once nations come to the negotiating table, is likely to contribute to a partial freeze in consumption and investment expenditure, with economic participants awaiting policy certainty or potentially lower prices if the tariffs are repealed. While inflation may be the lasting legacy of Liberation Day, given the deep integration in international trade, we expect it to be preceded by a slowdown in US and global growth as consumer and investment expenditure stalls.  

This macroeconomic backdrop has dispelled the “US exceptionalism” narrative. Far from the US offering a tailwind to global growth in 2025, as many had expected at the year’s outset, the US now poses near-term downside risk. A softening growth outlook has prompted a dovish shift in the forward rate market, which is now almost fully pricing in four Federal Funds Rate cuts by year-end, despite the ongoing trade war. 

Ironically, the isolationist MAGA policies, which include restraining US North Atlantic Treaty Organization (NATO) contributions and military support for European allies, have laid the grounds for elevated fiscal expenditure on state security and infrastructure in Germany and the broader Euro area. This has elevated medium-term growth prospects and mitigated European financial market losses relative to those in the US. In the East, China remains marred by choking deflations and economic stagnation. The devolving trade conflict with the US, China’s largest trade partner, now presents a further challenge to its economic revival.  

The GNU fallout elevates RSA sovereign risk 

Domestically, the fiscal estimates tabled in the national budget were pragmatic and credible. They struck a suitable balance between a continued commitment to debt containment, social security, and growth-enhancing capital formation. However, limited fiscal flexibility remains a constraint for government finances in the medium term. The need to increase VAT by a cumulative 1% to address expenditure pressures bears testament. As a small, open economy, South Africa remains highly exposed to exogenous shocks, with little room for meaningful counter-cyclical fiscal measures in the event of an economic downturn.  

Despite the credible numbers, the tabling of the budget was overshadowed by the spectacular souring of relations between the African National Congress (ANC) and the Democratic Alliance (DA) – the key coalition partners in the Government of National Unity (GNU). This coalition was formed following the national elections in May 2024, in which no party secured an outright majority to govern the country. The centrist DA’s elevation to government ushered in a wave of optimism hinged on its ability to influence policy formation and contribute to fast-tracked policy implementation after a decade of economic stagnation. South Africa’s sovereign risk premia narrowed significantly following the GNU’s formation, with domestic nominal bonds enjoying strong capital returns.  

However, the eleventh-hour postponement of the national budget in February signalled serious strain within the coalition. This tension culminated in the DA voting against the adoption of the Budget in Parliament in March, threatening the survival of the GNU as we know it. Uncertainty now surrounds the coalition’s durability and composition, which has roiled the domestic bond market – pushing the nominal bond curve higher and steepening it sharply in recent weeks. 

Headline consumer price inflation was unchanged at 3.2% year-on-year in February. We expect consumer prices to rise in 2025, but inflation expectations remain well-anchored towards the South African Reserve Bank’s 4.5% inflation target. Moreover, in the near term, the benign inflation outlook will be supported by threats to global growth and easing energy prices. Beyond this, escalating trade tensions risk disrupting supply lines and threaten long-term producer and consumer price stability. This backdrop will challenge the South African Reserve Bank’s (SARB) conservative approach in this interest rate cycle, with elevated real interest rates suppressing cyclical growth.  

However, it is important to differentiate between short-term growth upside from lower interest rates and the much greater structural growth needed to address South Africa's fiscal and socio-economic challenges. The responsibility to cure this latter growth shortfall falls on the other organs of state and will serve as the ultimate measure of success of the GNU.  

Short-dated bonds outperform in the uncertainty 

The domestic nominal yield curve shifted higher and steepened in March. The ALBI 1–3-year segment was the top performer of the nominal bond curve, returning 0.80% over the period relative to the ALBI total return of 0.19%. Cash, as proxied by the STeFI Call Deposit Index, returned 0.61% in March, while the IGOV Index, comprised of sovereign-issued local currency inflation-linked bonds (ILBs), returned -0.01%. 

Figure 1: Bond market index returns (periods ending March 2025) 

Source: IRESS, Futuregrowth 

THE TAKEOUT: The Trump administration has hit the ground running in pursuit of its incompatible MAGA objectives, hampering investor and consumer confidence and heightening market volatility. This has dented the “US exceptionalism” narrative, and far from offering a tailwind to the global growth outlook at the onset of the year, the US now poses near-term downside risk. Domestically, despite the credible numbers, the tabling of the budget was overshadowed by the spectacular souring of relations between the ANC and the DA – the key coalition partners in the GNU. Uncertainty remains on the stability of the working relationship between the parties, and by consequence, the survival of the GNU.  

Our investment view and strategy 

Politics will have an outsized influence on the performance of financial market assets in the months and years ahead as the Trump administration sets out to Make America Great Again. To date, this policy path has undermined investor and consumer confidence, the bedrocks of spending and investing. Heightened market uncertainty will likely translate into weaker macroeconomic growth outcomes in the near term and reinforce expectations of Fed rate cuts. This backdrop also supports arguments for domestic monetary policy easing, given still-modest economic growth conditions and range-bound inflation expectations.  

Locally, government finances show nascent signs of stabilisation but will remain an important watchpoint in our management of local currency bonds due to the strong link between macroeconomic conditions and government finances. 

The confluence of a seemingly stabilising fiscal position, despite GNU ructions, and an easing monetary policy cycle provides a favourable backdrop for nominal interest rate risk. The local bond market has paid back some of the extraordinary capital gains following the formation of the GNU, a development we had anticipated in recent months. The accrual offered by nominal bonds has anchored our investment strategy, but from a strategic perspective, capital return prospects have improved. The case for duration accumulation has therefore strengthened, given the current elevation and steepness of the nominal bond curve.  

The sovereign risk premium and inflation carry in ILBs remain attractive, offering tactical trading opportunities relative to cash in the coming months.  

THE TAKEOUT: Our investment strategy aims to strike a balance between: 1) capitalising on the base accrual (carry) on offer, especially relative to cash; 2) participating in the roll-down potential offered by short-dated bonds; and 3) active modified duration management, seeking to maximise capital gain opportunities.   

Table 1: Key economic indicators and forecasts (annual averages)  

Source: Old Mutual Investment Group