Economic and Market Overview: Quarter 1, 2021
The IMF continues to revise its global economic growth projections upwards. The global economy is now forecast to grow at 6% this year, compared to a contraction of 3.3% in the previous year. There have however been continuing warnings about widening inequality and divergence between developed and developing nations. Given the sheer size of the fiscal stimulus packages, there is the expectation that the USA will surpass the level of output it would have reached in 2021 in the absence of a pandemic. Many other developed markets will only reach pre-pandemic levels of output in 2022 with some emerging markets taking until 2023.
The US 10 Year treasury yield has risen from 0.91% to 1.74%. The 0.83% rise in yields can be attributed almost equally between the real component and inflation expectations. A continued rise in this yield remains a risk to equity markets going forward, especially for growth shares. The bond market is pricing in inflation breakeven rates of close to 2.6% over the next 5 years, which then drops to 2.2% over the subsequent 5 years. This is close to the Fed’s target rate. However, the risks of inflation surprising above these levels remains a concern. Short term pressures are already evident from pent-up demand and supply disruptions resulting in the Manufacturing PMI pricing index rising over 3%. US data surprises have remained positive, payroll reports have been robust, and US growth forecasts have been revised up sharply, narrowing the differential with China. In emerging markets (EM), China’s headline inflation contracted by 0.2% y/y in February from a contraction of 0.3% y/y in January. This deflation is on the back of falling meat prices, along with a drop in transport, apparel and utility costs. Elsewhere in emerging markets, the rollout of the vaccine in 2021 has been slow but is expected to contribute to further recovery in economic activity in the latter part of the year. Monetary policy settings have become more mixed, with some emerging market central banks signalling broad accommodation, while Russia, Turkey and Brazil’s central banks all raised interest rates in March.
The MSCI World Index increased by 3.4% in March as the global economy continued to recover. Countries such as the USA and the UK, which are ahead in their vaccine roll outs, have been outperforming those that are lagging. Those European stock markets which have lagged should see a recovery going forward as their roll-out eventually gathers momentum. European economies will also benefit from their greater sensitivity to global growth. European markets have a higher exposure to economically sensitive value sectors compared to the USA, which has a higher weighting in overvalued technology related sectors. Equity markets posted solid gains, returning 4.6% for the quarter. Markets were driven by developed markets (up nearly 5%), with the US even better (up nearly 5.5%). Emerging markets lagged, returning just over 2%.
In South Africa, real conditions warrant highly accommodative monetary policy given the high unemployment rate and muted credit growth. In contrast however, the FRA market and yield curve are telling the SARB it is supposedly behind the curve, with the FRA market discounting some rate hikes ahead. Even so, financial conditions do not reveal the need for tightening. Inflationary pressures are muted based on headline CPI, core CPI, and the latest BER inflation expectations survey. The ZAR has shown remarkable resilience and is in disinflationary territory. There are no obvious signs of imbalances from overly accommodative monetary policy. The current account was in surplus in 2020 and is likely to remain so in the short-term.
The biggest macro risk to SA is the fiscal position, but in this case the news has improved. Following a market-friendly budget, SARS confirmed a further R38bn revenue overrun, which could shave a further 0.8%/GDP off the budget deficit. Other highlights included the lowering of the corporate income tax rate to 27% as of 1 April 2022, the first reduction since 2008, while the excise duties on alcohol and tobacco products were raised by 8%. Treasury has lowered the weekly auction size by more than expected and importantly, the government has held firm on wage restraint. Investors, however, remained cautious over the path of recovery outlined by Mboweni, with Moody’s stating that the lower budget deficits were unlikely to prevent debt from rising. Fitch said the country still faced “severe challenges” to implement fiscal consolidation. The benchmark 10y SAGB rallied to 8.75% by the beginning of February but sold off over 100bps by the end of the quarter ending at 9.89%. Load-shedding is an ongoing constraint on investment, even if consumers and producers have managed to adapt to life with intermittent power cuts.
The South African economy grew by an annualised 6.3% quarter on quarter in Q4 2020, beating market expectations of a 5% increase, with eight out of ten industries reporting positive growth in the fourth quarter. As widely expected, the South African Reserve Bank (SARB) left the repo rate unchanged at 3.5% during its 25 March meeting, while also lowering its economic growth forecast for Q1 2021 to -0.2% from 1%. However, it lifted its projected total 2021 GDP growth to 3.8% from 3.5% previously due largely to accelerating global growth prospects. The ALSI posted a significant return of 13.1% for the first quarter led by Resources (18.7%), with Industrials up 13% and Financials lagging with a 3.8% return. The property sector posted a return of 6.4%. The All-Bond Index was down 1.7% with the impact of higher global yields outweighing the positive impact of a better-than-expected budget which helped the rand strengthen against the dollar by 2.6%. Non-residents sold a net R14bn worth of fixed-rate bonds market during March. Even so, year-to-date net inflows totalled R21bn on a nominal basis.
Source: 2IP, I-Net Bridge, BER, RMB Global Markets, Bloomberg, Stanlib Asset Management, Schroders, Stats SA, Prudential