Economic and Market Overview: Quarter 2, 2022

Global Markets

The first quarter of 2022 was characterized by extreme volatility in capital markets following the fallout from Russia’s invasion of Ukraine and the heavy sanctions consequently imposed on the Russian state, its leaders, and associated businesses. The volatility during the quarter was driven by geopolitical instability in Eastern Europe and its broader repercussions and increasingly hawkish expectations for interest-rate hikes as major central banks look to combat the not so ‘transitory’ inflation without derailing the economic recovery. In the US, February CPI rose to 7.9% year-on-year in February (the latest report showed CPI rose to 8.5% in the 12 months through March), the highest rate since 1982, as the key Energy Price Index in the US market recorded a 25.6% year-on-year increase. Wages continue to rise but have not yet matched the rate of headline inflation. 

The US Federal Reserve lifted its base rate by 25bps for the first time in 4 years at its March meeting, with inflationary pressures rising and energy prices now likely to be higher for longer due to extended sanctions. Fed Chair Jerome Powell acknowledged the inflationary pressure stemming from the Russian-Ukrainian crisis, but at the same time stressed how a broad-based surge in inflation demands a stronger approach to quantitative tightening. The US economy however remained resilient throughout the quarter with the year-to-date manufacturing activity continuing to find support in rising demand, and fewer supply-side COVID-19 related impediments to activity. The latest S&P Global Manufacturing Purchasing Managers’ Index (PMI) rose to 58.5 in March, from 57.3 in February. The US labor-market participation rate has also started to improve, with the jobless rate (down to 3.8% in February) already back at full employment. 

US companies continued to report strong earnings in Q1 2022, but poor sentiment combined with high starting valuations saw US equity markets recording weak first-quarter performances. The Nasdaq delivered an 8.9% loss with the stay-at-home tech favourites (i.e., Etsy, Netflix, Zoom and Meta) forming part of the $1.3 trillion drop in the market value of the Nasdaq 100 Index. The S&P 500 lost 4.6% posting its first negative quarter since the Q1 2020 selloff, while the Dow Jones retreated 4.1%. In the UK the Bank of England implemented its third 25bp interest rate hike in a row in March and warned of inflation reaching 8.0% year-on-year in April. However, the central bank was less aggressive in its outlook for rate hikes compared to the Federal Reserve, noting that the price shocks from the war were already taking a toll on consumers wallets. For Q1 2022, the UK FTSE 100 was flat. The Eurozone experienced a weaker recovery from the COVID-19 crisis than the US and UK, with Q4 2021 GDP growth at 4.6% year-on-year versus 6.9% and 6.5% for the US and UK respectively. In France, the CAC 40 lost 8.7%, while Germany’s DAX slumped 10.9% for Q1.

In the bond market, US Treasuries reacted badly to the deteriorating conditions, selling off heavily in March particularly at the shorter end of the curve with the Bloomberg Aggregate US Treasuries Index posting a 6.2% loss. The 50bp increase in the US 10-year yield was due to both a higher TIPS yield and wider breakeven inflation. This brought the Q1 increase to almost 100bp, taking the 10-year yield to almost 2.5%. Concerns over a Fed policy error intensified as the 2yr versus 10yr yield curve flattened persistently over the course of Q1, culminating in a marginal inversion at month-end. The US yield curve has historically been a reasonably reliable indicator of a growth slowdown and this time should be no different. 

In Japan, the Bank of Japan (BOJ) remained behind the curve with regard to raising its policy rates and left its policy rate unchanged. The 2021 GDP growth in Q4 was revised down to 4.6% year-on-year vs 5.6% year-on-year previously reported due to weaker-than-expected consumer spending as COVID-19’s influence was still being felt. The still-dovish BOJ stated that the Russia-Ukraine war has increased the risk of economic contraction in Q1, with the economy still needing accommodative policy to support growth. The market is forecasting no interest rate hikes through 2023. Japan’s Nikkei lost 7.5% for the quarter. 

The Chinese markets saw remarkable volatility in Q1 2022 as the economy expanded at the slowest pace in nearly two years over Q4 2021. This was due partly to COVID-19 infections and partly to ongoing debt problems in the property sector with giant developer Evergrande still causing waves, and other developer defaults. A worsening, widespread outbreak of COVID-19 infections prompted harsh shutdowns in major cities that disrupted economic activity during the latter part of the quarter and overshadowed January and February’s strong improvements in investment, industrial production and retail sales. The Chinese government has pledged to support the economy by further ramping up its infrastructure spending, easing bank reserve requirements to prompt greater lending activity and implementing more tax cuts among other measures to support economic growth.  Hong Kong and China’s equity markets sold off sharply on these developments as well as on additional investor concerns over the news of further strict regulatory crackdowns on businesses and a possible rift with Western countries over China’s “pro-Russian” stance on the war. Hong Kong’s Hang Seng and the MSCI China Index lost 6.1% and 14.2% respectively for the quarter.

Domestic Markets

The South African economic recovery was insubstantial posting 1.7% year-on-year GDP growth in Q4 of 2021. This brought full-year 2021 growth to 4.9%, slightly higher than expected. In Q1 2022, the Omicron variant of COVID-19 proved to be less disruptive to economic activity than originally feared, helping lift business and consumer sentiment. However, the largest boost came from rising global commodity prices, benefiting most SA mining companies and government tax revenues alike. The higher oil price did however hurt local growth prospects, but the country’s terms of trade improved which supported the Rand. This resulted in the Rand’s significant appreciation against the three largest global currencies. The rand was 9.8% stronger vs the US dollar, 13.1% higher versus the UK pound sterling and 11.6% up against the euro in Q1 2022. 

The unemployment rate however deteriorated further in Q4 2021, climbing to 35.3%, up from 34.9% the preceding quarter. The latest figures came in the wake of an easing in COVID-19 induced lockdown restrictions and the civil unrest witnessed last year with job seekers now returning to the market. According to Statistics South Africa the number of South Africans in jobs remains below pre-pandemic levels. Headline consumer prices (CPI) remained steady at 5.7% year-on-year in February unchanged from the month prior and slightly below consensus of 5.8%. The CPI number did not account for the 7.2% month-on-month increase in the cost of fuel in March. SA’s inflation dynamics have been notably different to the rest of the world with the wide output gap, resilient Rand and constrained wage growth limiting inflation pressures. The SARB continued the normalization process in March, hiking the repo rate by 25bp to 4.25%. Yet, the outcome was more hawkish than expected given the cautious statement and the fact that two of the five MPC members voted for a 50bp hike in a bid to stay ahead of the inflation curve. 

SA equities posted good gains during the quarter with the benchmark FTSE/JSE All Share Index (ALSI) gaining 3.8% even with Naspers and Prosus weighing the market down. The Resource and Financial sectors drove the market higher with returns of 18.2% and 20.3% respectively for the quarter. The FTSE/JSE Capped SWIX ALSI, which is a regularly used as the equity benchmark returned 6.7%. The All-Property Index retreated 1.6% and Industrials posted a significant drop of 13.1%, the latter hurt by over 30% declines in the values of Naspers and Prosus on the back of a further sharp sell-off in Tencent shares amid renewed Chinese government regulations.

At the same time, SA nominal bonds still managed to return 1.9% over the quarter, even as the SARB increased interest rates by 50bp. Shorter-dated bonds weakened but longer-dated bonds gained a little ground, resulting in a flatter yield curve. With SA inflation appearing not to be as much of a threat as earlier feared, inflation linked-bonds underperformed their nominal counterparts with a 0.3% return, reversing the longer-term trend, and cash (as measured by the STeFI Composite Index) posted a return of 1.0% in Q1 2022. SA’s benchmark 10-year yield ended the quarter at 9.90%, but a prudent budget and unchanged issuance was not enough to steady the market, as the war-induced sell-off intensified in March. Yields peaked at 10.70% – the highest level since the market dislocations in 2020.

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