Fixed Income Insights

The first quarter of 2019 was a smash hit for bulls. Capitulating central banks, record United States corporate share buybacks flushing the system with artificial liquidity and numerous bouts of monetary and fiscal stimulus from Chinese policymakers have lifted confidence of averting a Chinese hard landing scenario given China’s internal deleveraging and its external growth drag factor stemming from the US/China Trade dispute. Constant jawboning by dovish central bankers and sustained promises of progress on a US/China trade deal has been lending support to market. The perception that a deal is in the offing before end of the second quarter  is being increasingly built into asset prices as investors are factoring improving economic growth prospects and business confidence.

Recent weeks have also been characterised by collapsing yields which has been a positive for equity markets as equity earning yields look more favourable. The Federal Reserve (Fed) is signalling that they are on hold for the rest of the year as indicated on their latest dot plot forecast, together with signs of China stimulus starting to bear fruit. Hopes of a trade deal have conspired to produce a relentless 3 month move higher in equities, credit and other risk assets. Fundamental issues of slowing growth, a possible US corporate earnings recession and even a yield curve inversion (3month/US 10-yr UST spread) was surprisingly rendered irrelevant with most asset classes more than erasing their losses of a disastrous fourth quarter of 2018 and hurtling towards multi-year or all-time highs.

Market responses and asset returns are tell-tale that liquidity, easing financial conditions and central banks dominate.  Nothing else matters for now with only the wildcard being the US-Sino trade deal falling through, or the threat of US tariffs imposed on Eurozone for Airbus support and/or on its auto-sector seems to be identifiable issues that could upend and derail the buoyancy in markets. Optimism is back, and hope is pervasive that 2019 will replay the earnings recession case of 2016 meaning that all bad news is priced in, any slowdown will be temporary, and markets will resume their 10-year bull trend with new highs to come.

For now, we acknowledge the bullish narrative of Chinese stimulus enabling emerging markets (EM) and rest-of-world growth picture to start improving vis-à-vis the US and be more apparent as we move into the second part of the year. Part of this constructive outlook is premised on some fiscal easing in Europe and a lift in Chinese growth to help bring a more sustained recovery in Europe. Should this be combined with a resolution on the trade front with reversal or partial rollback of US tariffs on Chinese goods, one should expect the current regime to extend. This is increasingly being reflected in strong EM inflows and EM returns year-to-date with EMFX having lagged somewhat in the three main EM asset classes which has started to begin to play catch-up since early April.

According to Morgan Stanley data, year-to-date inflows into local, hard currency and exchange traded fund (ETF) and non-ETF vehicles that give exposure to EM Debt has been the strongest on record with year-to-date inflows exceeding $22 billion. Following the Moddy’s rating reprieve we have started to see inflows in South African Government Bonds (SAGBs) return with year-to-date purchases now almost doubling since the Moody’s announcement to R32 billion net foreign purchases. Of the year-to-date flows into EM debt globally only 10% has been flowing into local currency debt funds with the vast majority destined for hard currency EM debt funds. Last week the flows started shifting more towards EM local, which may bode well for EM local debt.

Our sense of the macro picture is that it is likely to remain supportive of EM. Hence South Africa is likely to also benefit and attract inflows with Moody’s recent credit opinion release maintaining SA credit rating as investment grade with a stable outlook. Moreover, with positive seasonal returns in rand and SAGBs around previous South African Presidential election cycles, we are reluctant to fade the recent rally as we expect bears to hibernate until signs of SA fiscal slippage concerns, Eskom operation and financial stress realities or global macro risk re-emerge.

The much-anticipated Budget Review, which has kept bond investors on edge has come and gone. The lead-up to this year’s budget was met with some investor trepidation as unexpected period of high level loadshedding by Eskom occurred in early February. After a blistering rally of over 7% by the rand in January it posted its worst February in more than a decade, with over 4.4% loss against the dollar. Post the budget announcement the rand’s carry appeal, a rally in commodities and the progress in trade talks have drowned out the noise around South Africa’s political and fiscal risks allowing the rand to stabilise somewhat.

In March, weaker global growth become an increasingly bigger concern that helped engineer a global bond rally. Local markets were in suspense at month-end, awaiting Moody’s action after the close of business. In the end, there was no action at all and, with the South African Reserve Bank (SARB) keeping rates on hold a day earlier, March was good for most assets classes despite the electricity blackouts earlier in the month and the rand ended the month another 3.1% weaker against the US dollar.

At the close of the last business day of the month, local equities were up, recording a monthly gain of 1.56%, despite the poor performance of some big names and the continuation of poor returns in the property sector, where a negative return of 1.46% kept the 12-month return in the red. Vanilla bonds generated a 1.28% return bringing the return for first quarter of 2019 to a total 3.76%, while inflation-linked bonds recorded a negative 0.77% and returning 0.5% , much less than nominal bonds . On a 12-month basis, vanilla bond returns fell further behind with the 7.26% return on cash, as the ALBI returned 3.45%. Equities scraped into positive territory on a 12-month basis, with the ALSI up 5.04%, while the property index return was -5.68%.

The budget speech delivered by Finance Minister Tito Mboweni had the bond market somewhat flustered initially, the rand sold off against the crosses. Yields spiked alongside this move, but as the Minister continued both settled down somewhat. The dollar/rand is trading around 1% firmer than its 2019 year-to-date weakest level of 14.37 posted on Budget Review day. 

The government presented a deteriorated set of fiscal figures since the Medium Term Budget Policy Statement (October 2018) because of tax revenue misses and the significant requirement for Eskom support. Eskom is slated to receive R23 billion per year for the next three years to support the urgent operational changes. We remain constructive that the rand  could benefit from China’s improving economic numbers as China sensitive and high beta currencies in EM high yielding space find appeal. But we remain cognisant that trade concerns may not necessarily subside post the US/China trade announcement as a US/China bilateral deal could have some problematic consequences for EM countries and US/China trade partners that suffer as a result of US and China redirecting trade. The Chinese yield curve out to 3-years has flipped from downward sloping curve to upward sloping suggesting that markets expect the central bank to reign in stimulus efforts in the months ahead which needs to be monitored for risk of wider disappointment in risk assets if PBOC alters its course.

Domestic realities have moved to the backburner for now, but fiscal risk focus is likely to return later this year. National Treasury judged Eskom Balance sheet to require additional support of around R150 billion. This would equate to a total of R230 billion over the next decade, or R23 billion per annum amortised over these 10 years. This huge and explicit commitment to Eskom provided for by National Treasury risks further fiscal slippage if economic growth in South Africa remains sub-par on the one hand, while on the other it illustrates that government views Eskom as too big to fail and of strategic national importance.

We also saw a set of spending adjustments to save R50 billion over the next three years in the February Budget Review. More than half of this will come from a reduction in the government wage bill through natural attrition alongside active measures to reduce compensation and encourage voluntary early retirement.

The National Treasury anticipates a consolidated fiscal balance of -4.5% of gross domestic product (GDP) in the coming fiscal year - meaningfully wider than MTBPS guidance and the consensus estimate of -4.0%. We think this may be overoptimistic and that wider deficit is possible. A large allocation to Eskom (R23 billion) in each of the coming three fiscal years has the effect of driving the debt ratio to 58.9% of GDP in 2021/22 - some 0.4% higher than MTBPS estimates. The positive currency and bond market response seems counterintuitive, given a breach in the expenditure ceiling, the costs of supporting Eskom, a deterioration in the debt ratio, and a significant increase in contingent liability provisions. It could have come in response to the ability to demonstrate that tough decisions around expenditure cuts can be made, or that the probability of Eskom contingent liabilities being realised has fallen. Ultimately more likely the rally was due to the market expressing more certainty that fiscal measures would be enough to stave of negative Moody’s action in March, which has proven correct in hindsight.

In general, the budget was bold on taking a new approach, but we remain sceptical on ability of government to execute on a lot of its promises most notably Eskom staff reductions and lowering of Government Wage Bill as per their estimates and timelines. This is based on track record of insufficient political will to cut/control government expenditures in areas such as wages and where it would be optimal. We would therefore guard against over-optimism post elections on the ability to introduce reforms that ignite growth, increase policy certainty and investment. We do, however, see scope of a smaller and more credible cabinet to be announced after the Cyril Ramaphosa inauguration on 25 May  on Loftus Versveld in Pretoria. The possibility exists for 34 ministries to be reduced to around 25 with Land and Agriculture ministries on the list for an amalgamation. While running long duration vs benchmarks on many of our fund positioning on a sustained basis since November, we intend using strength to move to an underweight positioning in the weeks ahead as long EM positioning becomes more crowded and valuations become more demanding. We think macro risk backdrop could shift to less favourable in the third quarter of  2019.

Our take of reasons why the initial bond market reaction to the budget was negative is due to wider deficits and higher Debt/GDP ratios. The SAGBs issuance will increased by R550m/week from April onwards. The recovery from initial bond selloff is largely due to consensus thinking that action announced on Eskom will be deemed as credit -neutral by Moody’s and that Eskom Sustainability Task Team (ESTT) will be credible and take action that addresses a lot of Eskom’s financial and operational concerns and to make headway in restructuring Eskom by mid-2019.

We highlighted three things below that stood out to us in the Budget last month:

  1. The Government has been prepared to go the partial privatisation route by announcing intention to seek strategic equity partnerships for Eskom transmission unit. This is likely ratings/credit positive if executed well.

  2. We expected to hear mostly ratings neutral/positive comments from ratings agencies. Moody’s being the most important at this stage as they are the only remaining agency rating us at IG. We believe the budget tabled together with the ESTT Eskom Turnaround plan meets the bar to keep Moody’s at bay from lowering their credit outlook on SA debt rating when they announce on 29 March. (see Chart 1)
  3. On PIT side, Minister Mboweni said that tax brackets will not be adjusted for inflation and hence there will be substantial bracket creep in the next fiscal year meaning most personal income tax payers will be paying more personal income tax to help NT meet their revenue goals.
Chart 1 - Eskom turnaround plan timeline

three pillars__
reconfiguration of eskom

legal separations_

Our defensive view on rand in March turned out to be correct. We maintain this but are carefully watching FX developments that could favour EM High yielding and China sensitive currencies post a US-China Trade Deal announcement.

Earlier in the year, we expressed a weak US dollar thesis and expressed an opinion that the rand could be a beneficiary of the Fed policy stance change, stronger commodity prices, EM flows and from US Treasury drawing down its cash reserves at the Fed hat creates more supply of USD in the system. The dollar/rand was able to move into the 13.00-13.50 range as we anticipated trading as strong as 13.2380 on 31 January 2019.

Subsequently, our view has changed on increased risks around Eskom headlines, the Budget and investment flows related to corporate activity. We flagged corporate unbundling activity can potentially lead to equity outflows by foreign investors and bring a negative flow impact to the currency.

Naspers spun off MultiChoice Group (MCG) to its shareholders on February 27 which will occur on the JSE. The ownership structure suggests that foreign funds could own 60% of MCG, split between MSCI EM-indexed investors and global tech-focused funds. The latter group could be potential sellers of MCG following the unbundling and separate listing, since their mandate would not involve ownership of this type of stock.

Multichoice is valued in the R65-79bn/US$4.8-5.8bn range which is placing MCGs equity at R150-180 per share. This estimate is based on target the FY2020 EPS estimate and using an EV/EBITDA multiple of 7-8x, in line with global peers. If foreign selling results in 20%-25% of liquidation it could result in $1-2bn off equity outflows in the month of March.

Besides the flow factors there was be an FX impact driving dollar/rand higher from foreigners hedging local SAGB holdings, from foreign investors who Moody’s ratings action as a threat to their South Africa exposure in their portfolios. We turned more bearish on the rand in our previous monthly Fixed Income Insights piece when dollar/rand was in the 13.25-13.50 range and would feel more comfortable to turn less defensive on the rand at levels of 14.40 or above. This was an accurate call and surprised us to see dollar/rand stalling near our 14.40 level on Budget day.

We previously highlighted that the pendulum has swung towards optimism when looking at ranges and changes to the dollar/rand FX vol surface in recent years when dollar/rand was trading closer to 13.50 area. Subsequently the vol surface as shifted higher and dollar/rand has also moved higher to trade just below the highs of the year to date range as the rand encountered headwinds from a stronger US dollar environment and from what appears to be negative equity and bond flows and net equity selling persists and research shows that foreigners opted not to reinvest their SAGB coupons of  R12 billion in March.

Chart 2 – Commodity price terms of trade
commodity price terms of trade V3

A correlation study of 60-day rolling correlation reveals that the rand is taking more direction, than it was a month ago from broad-based US dollar moves and less direction from the performance of its peer currencies (chart 3). The fact that most dollar/rand correlations have broken down could also be a signal that the rand has weakened due to coupon outflows. The rand seems more correlated to US equity performance of late and hence a melt-up in US stocks or much awaited correction in US equities is likely to impact on the rand. Net portfolio flows remained negative in February, after foreigners sold R6.4 billion worth of equities and only bought R2.5 billion worth of SAGBs but has started to improve after Moody’s decision. South African terms of trade (COMTOT) continues to move sideways (Chart 2) because higher iron ore and platinum prices are being offset by higher oil prices. The rand is close to fair value based on a PPP model basis, but the rand’s carry trade appeal and bullish momentum are waning.

The dollar/rand fair value based on inflation differentials is currently 13.20 rising to 13.70 at the end of 2019 and 14.22 at the end of 2020. According to RMB study, if one includes an index of industrial metal prices (deflated using US CPI) the fair value is 14.50, rising to 14.90 in the fourth quarter of 2019 and 15.52 by fourth quarter of 2020 if one assumes commodity prices remain broadly flat. While we remain more constructive on the rand in the near term expecting it to trade in the 13.85-14.40 zone, we think that FX implied and cross asset class volatilities seems very depressed and unsustainably low looking beyond this current quarter. Hence, we expect EMFX vol to rise and EMFX as an asset class to be very tied to how favourable the global macro backdrop remains post the US/China deal, trade discussions globally and China’s recovery or lack thereof. The PBoC policy and Fed Policy shifts will be an important driver for EM currencies in H2 if it were to shift to less accommodative should liquidity and monetary growth rise too fast and financial conditions become too easy that it poses financial stability risks that central bankers feel they need to address as they move to reign in excess liquidity.

Chart 3 – Dollar/rand rolling 60-day correlations

rand rolling correlations v2

The US-China Trade Deal Framework once finalise could have broad ramifications for the yuan and China sensitive currencies

The US/China trade negotiations are in its final innings and both parties are seeking to clinch a deal that is most beneficial for its economy without making concessions that would harm its longer-term objectives. Besides issues such as trade, IP theft and technology protection amongst others, there is a possibility that FX will also enter the trade deal.

United States  officials are supposedly seeking a pledge from China to keep the yuan stable and not use currency devaluation to counter the impact from US tariffs. This suggests that some currency language could be part of the Memoranda of Understanding (MOU) which shall form the basis of a trade agreement between the US and China. We are not entirely surprised by such a request, given that currency has been a core focus of the Trump Administration. Official comments and press statements from both sides alluded to currency discussions. More broadly, a clause on no competitive currency devaluation, amongst other provisions, was inserted into the text of the US-Mexico-Canada (USMCA or New NAFTA deal). A side deal on currency was also said to be part of the Korea-US Free Trade Agreement, although it was never made public and formally recognised by both parties. If an explicit currency pledge is part of a US-China trade deal, it could have ramifications on the US dollar and other major currencies, global trade, and certainly emerging markets.

Given the lack of details, at this point we remain somewhat in the dark. Will the pledge require China simply to not engage in competitive currency devaluation, as is the case with the USMCA’s currency clause or the typical G20 language, or an explicit commitment to keep the yuan stable? If it is the former, how binding and effective is it at a time when the authorities are doing little to encourage depreciation, and if anything, had spent much effort in stemming depreciation? In addition, China has already said that it would not engage in competitive devaluation and use the currency to boost exports or as a tool in the trade conflict. If the US is demanding exchange rate stability, is the yuan to be kept stable against the USD or a basket of currencies? The US administration should be far more interested in the USD/CNH or CNY cross. Will China agree to actively stabilise the renminbi or be less interventionist—which can be very nuanced.

If we get an agreement on currency stability, can it be a mild repeat of the Plaza Accord? The macroeconomic conditions between China and Japan is very different—China is much less developed than Japan was at the time and enjoys a far smaller overall current account surplus. Furthermore, the Chinese leadership, policymakers and even certain segments of the society are aware of the history and lessons from Japan’s Plaza Accord experience. The political resistance and cost of agreeing to something resembling the Plaza Accord may be too high.

A limited pledge is plausible. However, with the urgency to strike a trade deal with the US, China may be open to a request to keep the yuan stable for the time being and not carry out any one-off devaluation, to allay US concerns that China would blunt the tariff hit by weakening the currency and thus become less pressured to make progress on the stickier issues in the bilateral relationship or keep its side of the bargain.

Currency stability is not against China’s interests after all. One would be hard pressed to argue that this hasn’t been what the authorities had tried to accomplish for most of the second half of 2018 and through 15H2 and 16H2 , following revaluation of the renminbi. The authorities may also recognize the advantage of such a pledge in managing market expectations in the face of China’s shrinking current account surplus, which may be brought to the forefront in any trade deal involving large-scale purchases of US goods.

Though much of the purchases will probably be achieved via trade diversion from Europe and other countries, the market might see the trade deal as positive for the dollar given an expected improvement in the US’ external account. The FX stability would help attract capital inflows into China to offset any real or perceived deterioration in the current account, at least for the time being. But a long-term promise on a soft peg against the dollar or the CFETS basket would be a tall order for the Chinese authorities.

Perhaps we will see something on FX side more like the “Shanghai Accord”. Several months after the renminbi revaluation in August 2015, the world was staring at a bear market and a possible recession. In that December, the Fed carried out its first-rate hike since the 2008 crisis. A month later, the ISM declined to 48, the DXY was near its cycle highs, oil prices broke below $30/bbl, the S&P fell more than 10% in the span of two months. The US HY spreads saw wides post European periphery crisis. But in late January/February, there appeared to be coordinated actions across major central banks which have come to be known as a tacit “Shanghai Accord”, named after the meeting of G20 finance ministers and central bankers. The FOMC turned visibly dovish, the ECB hinted at easing, and the PBoC tried to instill FX stability via daily fixings. This doesn’t sound too different from the circumstances today. Perhaps we’re about to witness something akin to the “Shanghai Accord” rather than a new Plaza Accord.

How would the market react? A recent research report by CITI revisited both episodes and found similarities in market behavior. The key difference is that the impact of the “Shanghai Accord” was less pronounced and lasted shorter compared that of the Plaza Accord, which is understandable considering the latter’s explicit agreement and a much greater degree of coordination amongst the major central banks. Both events elicited a weaker USD, lower bond yields and easier monetary policies. If the US and China reach some sort of understanding on FX, the market reaction may well be similar, just differing in magnitude and duration depending on the commitment, expiry and enforceability. In the case of the Shanghai Accord USD-EM index weakened by over 5% in the space of 10 weeks following the “accord” date, suggesting a deal with similar features could boost many EM currencies. In fact, we think this move has already commenced as the market started to price in the likelihood of a US/China trade deal on EM bonds, equities and EMFX.

The Fed has already helped the cause by pivoting to the dovish side and removing a key pillar for dollar strength in early January of this year. Monetary and fiscal stimulus done by China is yielding green shoots, reducing the need for broad based monetary easing and offering support to the CNY. Together they would be a positive scenario for both EM FX and duration, extending the EM rally we’ve seen from Christmas into late second quarter or possibly into early third quarter.

The CNH and China FX proxies to benefit which would also include the rand. Despite the optimism to date, an agreement on trade and an MOU on currency management could still give the CNH a boost, in our view. We would be inclined to sell USDCNH on rallies into a deal, targeting the 6.60 level. Asian currencies, particularly those with a high export similarity with China, should also benefit, the KRW for one. Outside of Asia, the traditional China proxy currencies stand to gain.

If we’re right about the “Shanghai Accord” template, with the resulting outcome of a weak dollar and a dovish Fed, investors would be motivated to chase for carry. High yielding countries such as Indonesia, South Africa and Mexico could benefit from bond inflows, which in turn would boost their currencies in the absence of idiosyncratic risks. Duration in low yielding countries should perform alongside the US but may get less love from yield-seeking investors. For now, markets remain lackluster in anticipation of an announced date of a formal Trump/Xi to ink the final deal.

South African Presidential Elections

Recent polls suggest the African National Congress (ANC) will return to power with a slimmed-down majority of between 54% and 57% of the vote. The elections will also set the platform for the country’s post-election policy framework that some hope will prove more conducive for reforms to restore business confidence and brighten the economic outlook.

We are not convinced, and think the extent of the downturn already underway, the policy platform from the election manifesto, and underlying political economy constraints that exist within the ruling party and tripartite alliance risk frustrating market-friendly and pro-growth reform, even after the election is over. 

Long term, we note the progress made with improving governance and rebuilding key state institutions, but on their own these reforms cannot drive faster growth. Troublingly, the ANC’s election manifesto does not point to a shift towards a business-friendly reform agenda and a raft of decisions in recent months suggests an increasingly populist bias that will have weighed on business confidence and done little to boost productivity.

An update of our tactical and strategic views

Ahead of the Fed Budget we maintained a cautious stance on local SAGBs exposure but said we are  willing to move back to overweight duration at levels that met or exceeded 9.15% on the R186s if yields were to start blowing out on the current idiosyncratic risks. We opted to sit on the sidelines and use overshoot opportunities in yield backup episodes to increase exposure to long-end of the curve.

On Budget day the market initial reaction was outright negative as the entire curve sold off sharply. Given our expressed view last month to fade weakess closer to R186 yield of 9.15 it allowed us the opportunity to add duration into the selloff and cover UW positioning by extending duration on R2040s and R2037s. Subsequently the market traded stronger erasing losses and are moved firmer than pre-budget levels by some 20basis points by mid-March.

Given the fleeting nature of the selloff we were unable to extend duration as much as we intended but are maintaining a very mild duration overweight stance which we favour both tactically and strategically. While the momentum of the post budget rally has stalled in part due to uncertainty of Moody’s 29 March ratings announcement and due to a renewed bid in the dollar following a better than expected US fourth quarter 2018 GDP release, we felt comfortable to maintain our current positioning as we see as much as 50 to 70 basis points of risk premia embedded in SA 10yr bond yields (FV between 8.40 -8.60 vs. vs R186 near 8.68 during mid-March. Weighing all the events leading into Moody’s update and following several weeks of yield consolidation we felt that bond investors were compensated by enough of a risk premium embedded in bonds to maintain long duration exposure over Moody’s ratings update.

This view proved correct as bonds rallied some additional 20-25 basis points across the curve following Moody’s decision in their credit opinion released on 2 April with an even more comprehensive update published on 16 April. These updates have dispelled fears of an imminent outlook revision or downgrade risks on South Africa’s local currency long term credit rating and upon closer look reveals to us that assumption, forecast updates and methodology changes have raised the bar for downgrades to dub-IG for South Africa for the next 12 months and possibly beyond.

The confluence of prospects for continued inflows into EM, a return of another episode of EM carry into further Fed dovishness around quantitative tightening end by September 30 of this year,  softer than expected SA inflation readings, scope for continued incremental positive momentum on SOE reform agenda post elections and potential positive boost to EM from a formalised China/US Trade framework announcement could make for lower bond yields in the medium term in our view.

We have lightened bond exposure in the post Moody’s rally as we see risk of USTs and core bond markets moving up from depressed levels as global slowdown fears lose their sting. Chinese stimulus measures have possibly gone too far and Chinese yields in the front end of the curve are rising and is leading USTs by about 60 days (Chart 4) 

Chart 4 – Chinese bond yields are leading their global counterparts on the back of recent fiscal and monetary stimulus reigniting a depressed growth outlook   

china 10 year yield v2

We do, however, prefer to wait to add to our current duration only into weakness (ideally levels of 8.58 on R186 or above leading into the elections on 8 May. We are targeting levels near 8.25 on R186s and near or below 8.80 on R2030s to move to underweight duration as we anticipate event risks and volatility could start rising from May onwards as markets face news from local elects, Indian elections, European elections and Section 232 deadlines for US President Donald Trump to provide feedback on USTR report on European trade that could lead to imposition of auto tariffs by the US. All of these need to be monitored closely for its potential disruptive impact in a complacent volatility starved macro environment.

The risk to our mildly bearish USD narrative which is partly based on EU/Rest-of World (RoW) growth recovery vis-a-vis US & Fed on hold thesis is that the market currently “believes” US/China deal will be “successful” in frontloading $Tn 1.2 trade over 6yrs that leads approximately $200bn of Chinese imports halving the US trade deficit and hurtles the USD higher. This would pose a severe setback for EM assets.

A timeline of a proposed Eskom turnaround story has been communicated. While demanding we think the plan is credible. We do hold some skepticism around the ability to implement and execute the plan and to bring Eskom to a place of financial viability where it can service debt and maintain itself as an entity that does not require more than R20 billion per annum assistance from the fiscus. Having said this, we think it remains too early to fade the latest rally and to allow time for additional measures to be announced after the SA Presidential elections on 8 May. If historic patterns repeat, we could see seasonal pre-election rally in the rand and SAGBs which often takes place conditional on the external/global backdrop remaining steady or supportive of risk. We maintain option overlay strategies in many of our funds that can benefit from a grinding bull market punctuated with bouts of yield selloffs into the latter part of the second quarter. These can help us to take advantage of rallies but lower our overall portfolio or fund volatilities.

Beyond the Elections, we hold a more cautious view and would use market strength of bond yields trading closer to our fair values to move to an underweight positioning into meaningful rallies to protect portfolio gains.

From a domestic risk standpoint, we are mindful of a CRA (Center or Risk Analytics Report) that sketches their Most likely case for South Africa in the next year ahead.

Their “most likely 12-month long-term chain of events is that the ANC secures a mid-to-high 50s mandate in the May polls. Internal ANC dynamics prevent any reform and policy stagnation/contradictions crystallise. Gimmicks are substituted for real reform. Global circumstances remain net-neutral/negative for SA. Growth underperforms consensus forecasts by 50%. Unemployment and levels of economic exclusion deepen. Protest action and societal instability increases. Ratings downgrades follow, triggering significant investment and currency reversals. Debt and deficit numbers disappoint.” CRA Vol.1 2019 Report

From a global macro risk standpoint, we think tailwinds for EM can remain in the coming weeks as low global volatility regime persists, but we anticipate the low volatility regime shift to a higher vol regime to occur closer to May/June as global growth and company earnings growth risks mount and Fed and or PBoC policy risk come back into the markets visor.

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