The hawks continue to rule the roost

Global central banks doggedly stick to the task

With consumer price inflation at multi-decade highs in the past quarter, central banks across a swathe of developed markets doggedly stuck to the task of quelling this, with monetary policy rates at levels last seen prior to the global financial crisis of 2008.

While the monetary policy hawks continue to rule the roost, contributing to policy tightening intended to contain broad and stubborn inflation pressures, the forward guidance provided by some central bankers – with the incorporation of words like “slowing”, “pause” and “cut” in their commentary – indicates acknowledgement of the growing risk to macroeconomic growth in the coming years. In the case of the US, the deceleration in the pace of monetary policy tightening to 50 basis points (bps) in December by the Federal Open Market Committee (FOMC) relative to the 75bps increments preferred throughout 2022 speaks to the increasingly fine balance that will need to be struck between fending off inflation pressure and not unduly choking the economy of its growth potential.

As one would expect, financial markets tend to look beyond short-term dynamics. In the case of the US, the recent decline in longer-dated treasury yields, and consequently yield curve bull flattening, signals investor expectations of a near-term peak in both inflation and policy rates. Of course, this is not the case across all developed economies, with increasing evidence of an imminent decoupling in inflation dynamics and the consequent monetary policy response. In the UK and Eurozone, the delayed monetary policy response to the severest episode of inflation in four decades, partly due to the ongoing Russia/Ukraine military conflict, has resulted in peak inflation and monetary policy rates that remain clouded from view even as recessionary economic conditions begin to take root across the region. An ironic exhibit of Europe’s stagflation bind is the rejection of a 4% pay increase by European Central Bank staffers – and the suggested strike action in protest.

POLICY DETERMINATION WILL TEST ECONOMIC RESILIENCE

After a more resilient than anticipated Q3 of 2022 from a global growth perspective, high-frequency economic activity indicators in Europe in the fourth quarter point to a pending downturn. The clearest signals have come from global Purchasing Managers Indices (PMIs). The forward-looking components within the manufacturing subsectors of these indices require particular attention, with weak new orders and inventory levels suggesting that the worst is yet to come from an economic growth perspective, due to weakening demand for manufactured goods.

Read as a barometer for recession risk, the aggressive yield curve bull flattening (and consequent curve inversion) in the US highlights market expectations of an impending recession. Although musings of a hard landing have lingered for some time, these risks are not reflected in default expectations or valuations.

In mainland China, the easing of stringent lockdown restrictions will aid the easing of supply-side constraints and moderately buffer global economic growth downside in 2023. However, the lesson from the awakening of the rest of the world to a post-COVID reality highlights the risk that China could initially see a jump in infection and transmission rates that could impair the mobility of its citizenry before a more sustained rebound in economic activity in the latter part of 2023.

Figure 1: Developed economies are increasingly drifting towards the stagflation zone

Source: Bloomberg, Futuregrowth

“HIGHER FOR LONGER” IS THE NEW ORDER OF THE DAY

Consumer inflation remained significantly above central bank targets across the developed world in the past quarter, as we expect to be the case for the year ahead. “Higher for longer” would seem a suitable mantra for global monetary policy rates in the foreseeable future, as central banks contend with a higher sacrifice ratio (the loss in economic growth and employment required to rein in inflation) compared to the 1980s, given the globalised nature of the current inflation bout. However, it is important to not lose sight of the increasing evidence of a moderation in the rate of inflation across several economies. In the US, a telling indicator of the moderation in the rate of inflation is the seasonally adjusted rolling 3-month annualised rate of change for both the Headline and Core PCE (Personal Consumption Expenditure) deflator data series. This is supported by the fact that crude oil prices, grain prices and the CRB (Commodity Research Bureau) Food Price index are all off their more recent peaks.

Further to this, the combined effect of significant dollar strength, slower economic activity, the continued unwinding of supply chain bottlenecks, the slow normalisation of shipping activity and the cost thereof are also contributing to some pipeline price pressure relief.

THE SLOW GRIND BACK TO THE INFLATION TARGET BAND CONTINUES

South Africa’s Headline Consumer Price Index (CPI) accelerated by 7.4% year-on-year in November from 7.6% the previous month. This confirms the peak at 7.8% in the third quarter of the year and we expect a further moderate receding of inflation pressures in the coming months. In contrast to the turn in domestic headline consumer inflation, albeit very slowly, Core CPI remained sticky at its recent peak of 5.0% in November.

Hot on the heels of this inflation print, the South African Reserve Bank (SARB) hiked the repo rate by 75bps at its final Monetary Policy Committee (MPC) meeting of 2022, delivering a cumulative 325bps of hikes for the year and a consequent year-end repo rate of 7.0%. While the 3:2 vote split by the five-person MPC in favour of a 75bps policy hike relative to 50bps increments points to the nearing peak in the cycle, Governor Kganyago’s highlighting of the committee’s bias to over-tighten in the post MPC Q&A serves as a warning of the SARB’s hawkish bias in the current interest rate cycle – and its intent to unequivocally rein in inflation risk.

Figure 2: South Africa Headline Consumer Price Inflation (CPI)

Source: OMIG, Futuregrowth

THE MEDIUM-TERM BUDGET POLICY STATEMENT IS AMBITIOUS BUT FLAWED

The tabling of the Medium-Term Budget Policy Statement (MTBPS) on 26 October 2022 confirmed general market expectations of stronger fiscal consolidation for the current fiscal year. Primarily due to corporate income tax revenue collection continuing to steam ahead of conservative budget estimates, the budget deficit for the 2022/23 fiscal year is now estimated to contract to 4.9% from a previous estimate of 6.0%. While expenditure was adjusted higher and real gross domestic product continues to undershoot budgeted expectations, the net effect of National Treasury’s adjustments allows for a decline of the gross loan debt to GDP ratio from 72.8% to 71.4% in its estimates. However, disappointingly, no details were provided regarding the long-awaited transfer of a portion of Eskom debt onto the sovereign balance sheet. National Treasury has now committed to furnishing this detail in the tabling of the Budget in 2023. Estimates for the forthcoming fiscal years are particularly optimistic, with the first primary surplus in fifteen years expected for the 2023/24 fiscal year and the consolidated budget deficit to narrow to 3.2% of GDP in 2025/26. This is mainly the result of expected sustained strong tax revenue collection and relatively contained expenditure. Consequently, the gross debt to GDP ratio is expected to narrow to 70% in the outer years of the medium-term expenditure framework. The clear intention to accelerate fiscal consolidation is commendable and was trumpeted by market participants.

However, given South Africa’s structural economic growth constraints and elevated expenditure pressure, we continue to caution against the significant fiscal execution risk in the medium term. Moreover, while Eskom’s dark shadow continues to blight economic growth and fiscal consolidation prospects, Transnet has now worryingly joined the ranks of the beleaguered state-owned enterprises clambering for fiscal support – only further impinging on fruitful, growth-enhancing fiscal expenditure in the medium term.

Figure 3: Despite recent progress, the level of outstanding sovereign debt and contingencies remains too high

Source: National Treasury, Futuregrowth

POTENTIAL GREY LISTING REMAINS A PROMINENT RISK

The Financial Action Task Force (FAFT) evaluated South Africa in October 2021 and found several deficiencies in the country’s policies and efforts to combat money laundering and terrorism financing. The FATF reviewed South Africa again in October 2022 to gauge if enough progress had been made to combat money laundering and terrorism financing, and to assess whether the country has a credible plan to deal with areas of concern.

Although significant progress has been made in terms of addressing the deficiencies pointed out by the FATF in 2021, much of this has been on the legislative side. The FATF is due to have a plenary meeting in February 2023 where it will be decided whether to add South Africa to the grey list. While the legislative changes are progressive, our view remains that a turnaround from a law enforcement implementation perspective will take some time. As a result, we see it as probable that South Africa will be added to the grey list, inhibiting much-needed foreign direct investment (FDI). Please see here for a more comprehensive analysis.

AMIDST THE VOLATILITY, NOMINAL BONDS SIGNIFICANTLY OUTPERFORM

Following a rather uneventful October for the domestic nominal bond market, where the FTSE JSE All Bond Index (ALBI) returned 1.07% for the month, the following two months of the quarter were marked by a heightened degree of return volatility owing to a combination of stronger global bond markets and a recovery in the rand in November, together with heightened local political uncertainly in December brought on by the Section 89 Parliamentary Panel findings against President Ramaphosa related to the theft at his Phala farm. Against this backdrop, the ALBI returned a heady 5.68% for the quarter, led by the 6.30% return for the 7- to 12-year maturity segment. Indicative of the market volatility in the quarter, the benchmark 10-year maturity R2032 government bond traded within a wide range of 10.67% to 11.52% over the period. The FTSE JSE Government Inflation-linked Bond Index (IGOV) returned a comparatively modest 2.22% for the quarter, as the benefit of the exceptionally strong inflation accruals enjoyed by the asset class in the past year starts to wane. Cash was the laggard from a return perspective across the interest-bearing asset class for the quarter, rendering a return of 1.54%.

Figure 4: Bond market index returns (periods ending 31 December 2022)

Source: IRESS, Futuregrowth

// THE TAKEOUT

Global central banks doggedly stuck to the task of reining in consumer price inflation which had been at multi-decade highs in the quarter. This resolve has raised nascent concerns for economic growth downside in 2023. Locally, CPI data prints in the quarter have confirmed that we are beyond the peak in the current inflation cycle, and are slowly trudging back to the upper bound of the inflation target band. On the fiscal front, notwithstanding downward growth revisions in the medium-term, the recent corporate income tax windfall has confirmed our expectations of stronger fiscal consolidation for the current fiscal year. We, however, remain alert to the still significant fiscal execution risk in the medium-term. Even so, amidst heightened return volatility in the quarter, the ALBI returned a heady 6.41% for the fourth quarter of the year. The IGOV returned a comparatively modest 2.47%, and cash was the laggard in the interest-bearing asset class, returning 1.64%.