Global economic developments.
United States (US)
Conflicting economic outcomes temper rate hike expectations
The US Federal Reserve (Fed) left interest rates on hold at the March rate-setting meeting, in line with the consensus expectation, at the effective rate of 0.36%. The Fed continues to face conflicting signals in the real economy. While labour market data paints a robust employment picture in the US, growth momentum overall has slowed.
The Bloomberg consensus has downgraded real GDP growth forecasts for the region down from 2.8% in May 2015 to 2.1% in March 2016 (a tad higher than potential growth of 2%).
Chart 1: Average US wage inflation inching higher (%)
Source: Bloomberg, Momentum Investments
Subdued international oil prices have been a major negative contributor to headline inflation in the US. Even if oil prices remain around their current levels, Capital Economics expects energy inflation to rise from its current negative rate to zero during 2017. US headline inflation has also been suppressed by dollar appreciation, but the dollar has more recently weakened by over 3% on a trade-weighted basis between December 2015 and March 2016, suggesting upward momentum in core prices. Core or underlying inflation (i.e. headline inflation excluding the prices of food and energy) is set to rise further on the back of reasonably firm demand and a steady rise in wage growth (see chart 1).
Although further mentions of global growth and financial market concerns by the Fed has left the market implied probability of a rate hike (at the June meeting) at only 20%, the expectation of a rising inflation profile and a moderate expansion in GDP likely still supports the view for two interest rate hikes of 25 basis points each over the course of 2016, in line with the Fed’s downwardly-revised median expectation.
Eurozone
European Central Bank (ECB) unleashes further stimulus
In response to weaker than expected growth and subdued inflation, the ECB cut all three of its interest rates and expanded its asset buying programme by a further €20 billion to €80 billion per month, which was above the consensus expectation for an increase to €70 billion.
The ECB continues to view growth risks as being to the downside in light of softer emerging market growth, financial volatility and slow momentum on structural reforms.
The ECB’s deposit rate was cut by 10 basis points to -0.4%, while the main refinancing rate was reduced to zero from 0.05%. The marginal lending rate (the rate used by commercial banks to borrow from the ECB overnight) fell to 0.25% from 0.3%.
The announcement, which also included news that the ECB will be expanding purchases to corporate bonds and implementing a new Long-term Refinancing Operation (LTRO), initially surprised the market positively. However, the subsequent reaction to ECB President Mario Draghi’s comments in the Q&A session that followed the statement was not received favourably. After announcing that “rates will stay low, very low, for a long period of time and well past the horizon of our (ECB) purchases” earlier in the address, he intimated that the ECB did not anticipate the need for a further reduction in rates.
Chart 2: Persistently negative output gap (%)
Source: IMF, Momentum Investments
Further growth disappointments could result in the output gap (actual less trend growth) remaining in negative territory for some time (see chart 2), supressing inflation and forcing the ECB to maintain easy monetary policy well into 2017.
Japan
Consumer confidence implodes on negative interest rate announcement
Real GDP growth forecasts have tumbled from an expectation of 1.4% in 2016 in May 2015 to 0.6% ten months later. Household consumption growth remains mild at best, while growth in fixed investment and exports ticked lower into negative territory in the final quarter of 2015 (see chart 3).
Moreover, inflation pressures are largely absent. Consumer price inflation (CPI) data revealed that prices were only 0.3% higher in February 2016 than a year ago, significantly below the central bank’s target of 2%.
Asset purchases by the Bank of Japan (BoJ) have seen their balance sheets expand to 77% of GDP in 4Q15 from 21% in 4Q07, while the Bank has run near-zero interest rates since the early-90s. However, with growth stalling and the BoJ remaining a long way off from its 2% inflation goal, the Bank turned to cutting interest rates into negative territory.
Chart 3: Japanese growth momentum slowing
Source: Bloomberg, Momentum Investments
By implementing a tiered system of rates on bank reserves held at the BoJ, authorities expected damage to bank profitability levels to be limited, yet there was a strong negative reaction to the announcement.
Japan’s ten-year breakeven inflation rate dipped to a low of close to 0.1% following the announcement (but has since retraced to 0.4%), while consumer confidence fell. The deterioration in consumer sentiment could be the result of Japanese households preferring to hold physical banknotes rather than experience a decline in their bank accounts in nominal terms. Nearly 20% of banknotes (as a share of GDP) are in circulation in Japan relative to 11% in the Eurozone or 2% in Sweden where central banks have already experimented with negative interest rate policies.
Hopes of higher growth are pinned to Prime Minister Abe’s “third arrow” which contains over 200 pro-market measures, but businesses have been disappointment by the pace of reform resulting in dull future growth prospects.
Emerging markets (EM)
EM growth forecasts pulled to below 2015 levels
EM growth forecasts have been pulled down further to the extent that the market now sees the expansion in real GDP this year slowing from the pace observed over 2015. The gap between the composite PMI readings of developed versus emerging markets has narrowed mostly owing to a deterioration in DM prospects rather than a reacceleration in EM (see chart 4).
However, the stability in the Chinese currency, relatively stable oil prices and supportive developed market central bank policies could provide some support for growth in the region this year.
Risk appetite in this asset class has improved markedly following the Fed’s communication that fewer rate hikes and a more protracted interest rate cycle was likely to take place given growth and financial market stability concerns. Moreover, oil prices look set to drift marginally higher into next year.
Dispersion across EM countries persists. The commodity-exporting bloc is likely to continue facing stagflationary pressures as currency weakness keeps inflation elevated, while countries within Emerging Asia and Eastern Europe are likely to ease policy rates further on low inflation pressures thanks to subdued oil prices. Net commodity exporters are also facing increasing budgetary constraints leading to lower credit worthiness scores.
In China, we expect slow and steady growth in the household consumption and services sectors of the economy, while heavy industry zones are likely to remain depressed with a limited spill-over onto the rest of the economy. We expect targeted stimulus to continue to maintain growth rates in line with the country’s five-year plan including further fiscal stimulus, lower interest rates to encourage households to borrow more and lower reserve requirement ratios to buoy the property market.
Chart 4: EM PMI remains in unfavourable territory
Source: Bloomberg, Momentum Investments
Local economic developments
Reserve Bank hikes rates to 7% to limit economic cost of rising inflation and sticky inflation expectations
Despite a weaker growth outcome, the South African Reserve Bank (SARB) hiked the repo rate by 25 basis points to 7.0% in an effort to abide by their inflation-targeting mandate. This was in line with just under half of the economists polled by Bloomberg.
The SARB noted that EM weakness had pulled global GDP prospects lower. They view geopolitical uncertainties, China’s move to a less commodity-dependent growth model and financial market volatility as key risks to growth outlook. Though the SARB downgraded their expectations on real GDP growth from 0.9% in 2016 to 0.8% and from 1.6% to 1.4% in 2017, we still see scope for further downward revisions. Muted global trade conditions and rising domestic headwinds have led us to downwardly revise our internal real GDP growth forecasts to 0.6% this year and 1.2% in 2017.
The Reserve Bank admitted that the inflation forecast had improved moderately (see chart 5) since the January meeting of the Monetary Policy Committee (MPC) due to the higher interest rate assumption (following the 50 basis point hike in January), a slight retracement in the currency, downward revisions to international oil price assumptions and a lower than anticipated hike in the electricity tariff.
Chart 5: SARB headline CPI forecast revisions (%)
Source: SARB, Momentum Investments
The Bank continues to emphasize the risks of keeping interest rates at artificially low levels which could come at the cost of rising inflation and higher future inflation expectations. Moreover, the SARB continues to view the stance of monetary policy as accommodative. As such we still anticipate a further 50 basis points worth of interest rate hikes over the course of the next twelve months to address inflation risks, which is expected to leave real policy rates at close to 1% over the corresponding period.
Financial market performance
Global markets
World stock markets rebounded sharply in March 2016 as risk appetite improved. The VIX volatility index fell by seven points while commodity prices recovered by 4.1% over the corresponding period.
The MSCI All Country World Index (ACWI) surged ahead by 7.6% in the month. Developed markets ended the month 7.1% up, led higher by a 7.0% increase in the S&P 500 Index on the back of comments that the US Fed would “proceed cautiously” in their interest rate hiking cycle, a recovery in oil prices and a bottoming out in negative economic surprises in China. This was followed by a decent performance in Japanese and European markets. The Nikkei 225 Index increased by 5.4% in March while the Eurostoxx 50 Index experienced a 2.4% uptick over the corresponding period.
The recovery in commodity prices and an improvement in risk sentiment indicators led to a sharp 12.8% recovery in the MSCI Emerging Markets Index. The best performing region was Latin America, followed by Europe, Middle East and Africa (EMEA). The MSCI Emerging Markets Latin America Index posted a phenomenal 21% rebound in March, while the MSCI Emerging Markets EMEA Index recorded a robust 14.7% return. The MSCI Emerging Markets Asia Index climbed by a healthy 11% over the same time period.
Chart 6: Local asset class returns
Source: Bloomberg, Momentum Investments, data up to 31 Mar 2016
Local markets
The local market was swept up by the positive mood in world markets. The South African equity market (FTSE/JSE ALSI) ended March 6.4% higher, buoyed by the 11.5% gain in the FTSE/JSE Financials Index. Resource stocks benefited from higher global commodity prices and less negative Chinese sentiment. The FTSE/JSE Resources Index gained 5.1% over March, followed by a 5.0% rise in the FTSE/JSE Industrials Index.
The performance between mid- and small-caps in March was reasonably similar. The FTSE/JSE Mid-cap Index gained 8.5% in March, while the FTSE/JSE Small-caps Index ended the month 8.3% firmer.
The ALBI moved up by a marginal 2.6% in March (SA ten-year yields rallied by 29 basis points). Meanwhile the listed property sector posted strong gains of 9.5% on the back of the bond yield rally and better than expected distribution growth for some of the larger counters. SA cash was the worst performing asset class in March, earning only 0.6%, followed by a mild 1.0% gain in inflation-linked bonds.
The rand appreciated steadily over the month in line with a firmer Brazilian real, Russian rouble and Colombian peso (amongst other emerging market currencies) as the US dollar came under pressure on dovish comments made by the US Fed. The rand ended March 8.1% firmer against the US dollar and 3.3% sturdier against the euro.