Market Overview

13 September 2022

“The global economy is being redesigned in the midst of multiple crises: surging inflation, the Covid-19 endemic, continued war in Ukraine and the current bear market. Against this backdrop, businesses face rising energy bills, surging inflation, the prospect of higher interest rates and across the world, a shortage of workers.” Bloomberg Technology Summit.

Most global markets maintained upward momentum during the first half of August as investors shifted their focus towards expectations for easing monetary policy in the United States (US) given that inflation had presumably peaked in June. Commentary at the time from central bank members alluded to the notion that the pace of rate hikes would begin to decelerate, supporting sentiment and global equities. The second positive push was driven by the most recent US inflation print which showed that the pace of price increases slowed ahead of expectations in July as energy costs dropped, pulling the annual reading down slightly from a four-decade high.

The narrative for a more dovish central bank combined with peak inflation led to a rally in equity markets, causing financial conditions in the US to loosen. However, this was contrary to what the central bank was trying to achieve, which resulted in several Federal Reserve (Fed) members reassuring the market that they would maintain an aggressive stance, noting that the US economy would need a tight monetary policy “for some time” before inflation in under control. This led to another round of heightened risk-off sentiment in the markets, wiping out most gains for the month, with financial conditions beginning to tighten once again.

The reiterated hawkish stance remains at the forefront, even though US inflation is starting to ease. This is due to a fairly robust labour market, especially when considering wage growth, with gross domestic income also remaining relatively strong. The Fed would want to see a significant loosening in the labour market, hence the need for prolonged intervention. While this continues to fuel recessionary concerns, the contraction is likely to be shallow since it will be Fed induced and not due to any structural issues, as seen back in the 2008 financial crises. Overall, the S&P 500 was trading down ~2% towards month end as a result of the large pullback. The dollar trended to the upside given that the US economy continues to outperform other key markets that continue to face several issues.

European markets that were range bound for most of August also retreated heavily towards the month end. The energy crisis within the region, which was spurred on by disrupted exports of Russian gas to Europe, remains a key concern and has forced European leaders to improvise bailout plans and emergency measures to offset the impact on consumers come winter. In terms of central bank activity, the market has priced in additional rate hikes, especially in the United Kingdom (UK). And there is growing recessionary concerns as spiking natural gas prices have been wreaking havoc across the continent, turbocharging inflation and hamstringing industries.

Looking at the Asia-Pacific region, China recently announced 19 new policies (including a further ~$146 billion in assistance which will target infrastructure, property, and private business). This is aimed at boosting its efforts to rescue economic growth, which was disrupted yet again by a resurgence in Covid-19 cases, a deepening property crisis, and now power shortages spurred by a severe drought.

Locally, the South African market continues to face several idiosyncratic risks, especially on the political front. However, the Johannesburg Stock Exchange (JSE) remains dominated by the global macro rhetoric. July’s inflation print of 7.8% likely marks a monthly peak in headline inflation as fuel price pressures have moderated since July. However, worries about second-round effects from elevated food and fuel inflation, which could be exacerbated by import price pressures as the rand has weakened against the dollar, remain a concern. Overall, the All Share Index inched into positive territory for the month while the weaker rand hovered just below the R17/$ mark. Bonds, both locally and offshore, remained volatile but strengthened towards the latter half of the month given the reiteration of the Federal Reserve’s hawkish stance and are offering good value at current levels.

ECONOMIC DATA REVIEW

US inflation moderated slightly, however, Fed’s members maintained a hawkish stance

The S&P Global Composite Purchasing Managers’ Index (PMI) is expected to be revised lower to 45 in August 2022, down from a final reading of 47.7 the month before, signalling a further decline in total business activity. Retail sales, however, increased 10.3% year-on-year and exceeded expectations of 8.1%. The trade deficit narrowed to a sixth-month low of $79.6 billion in June, compared to forecasts of $80.1 billion, as exports reached yet another record high, while imports remained pressured by slowing domestic demand. The unemployment rate decreased to 3.5% in July, slightly better than market expectations. Annual inflation slowed more than expected to 8.5%, from a 40-year high of 9.1% in June. Gross domestic product (GDP) contracted by an annualised 0.6% in quarter two of 2022, which was slightly less than estimates for a 0.9% fall, due to upward revisions in consumer spending and inventories. Still, the economy technically entered a recession, following a 1.6% drop in quarter one of 2022. During his speech at the Jackson Hole symposium, Fed Chair Jerome Powell highlighted that a reduction in inflation would require a sustained period of below trend growth, but also mentioned that failure to restore price stability would have a further negative impact. Most importantly though, Powell stated that another unusually large increase could be appropriate at the Fed’s next meeting but that the decision for September will be dependent on the totality of incoming data as well as the evolving outlook. He also added that at some point, as the stance of monetary policy tightens further, it likely will become appropriate to slow the pace of increases.

Eurozone inflation reaches a new record high with further rate hikes expected going forward

On a preliminary basis, the S&P Global Eurozone Composite PMI fell to 49.2 in August, compared to 49.9 a month ago. This was marginally behind expectations. Retail sales were down 3.7% year-on-year, the first drop since February 2021, and were much lower than market forecasts of a 1.7% decline. A trade deficit of €24.6 billion was posted in June, compared to a surplus of €17.3 billion in the same period a year ago, as imports surged 43.5% year-on-year and exports rose at a softer 20.1% year-on-year. As expected, the unemployment rate remained unchanged at 6.6%. Annual inflation was confirmed at a new record high of 8.9% as prices of energy, food, alcohol and tobacco, and services all accelerated. European Central Bank (ECB) policymakers advised that the 50 basis points rate hike delivered in July be regarded as frontloading the exit from negative rates, and essential in normalising monetary policy. Policymakers also noted that additional increases in borrowing costs will be made on a meeting by meeting basis and will be data-dependent, though further hikes in upcoming meetings should be appropriate.

Soft data out of the UK with inflation having increased ahead of expectations

According to preliminary reports, the S&P Global/CIPS UK Composite PMI dropped to 50.9 in August, below market expectations of 51.1, due to a faster decline in manufacturing output and a slowdown in services activity. Retail sales volumes decreased 3.4% year-on-year, compared to estimates of a 3.3% decline. The trade deficit broadened to £11.4 billion in June, from a downwardly revised £9.1 billion in the previous month, as exports fell faster than imports. The unemployment rate was in line with expectations of 3.8%. Annual inflation surged to 10.1%, slightly above expectations. During its August 2022 meeting, the Bank of England (BOE) raised its main rate by 50 basis points to 1.75%, marking the sixth consecutive rate hike, and the highest increase since 1995. This effectively pushed borrowing costs to its highest levels in over 13 years. Looking at growth, the UK is now expected to enter a recession in the fourth quarter of the year.

Economic readings out of China remain weak due to pressure in the property market and ongoing Covid-19 headwinds

China’s composite PMI fell to 54 in July from an 18-month peak of 55.3 back in June and was slightly below market forecasts. Retail sales increased 2.7% year-on-year, well below consensus expectations of 5%. The trade surplus surged unexpectedly to a record high $101.3 billion, compared to $55.9 billion over the same period a year ago, and was far above the forecasted deficit of $90 billion. Exports grew 18% year-on-year, while imports rose at a slower 2.3%. The surveyed urban unemployment rate edged lower to 5.4% in July amid the government’s continued efforts to revive the economy by easing Covid-19 restrictions. China’s annual inflation rate rose to 2.7% in July, compared to market forecasts of 2.9% as food prices continued to rise. The People’s Bank of China lowered its key loan prime rates (LPR) at August fixing, the second reduction this year as the board made additional efforts to revive borrowing demand amid repeated Covid-19 outbreaks and lingering pressures in the property market. The one-year (LPR), which is used for corporate and household loans, was cut by five basis points to a record low of 3.65%, while the five-year LPR, which influences the pricing of home mortgages, was slashed for the second time this year by 15 basis points to 4.30%. This decision came after the central bank unexpectedly trimmed the one-year medium-term lending facility rate and another short-term liquidity tool earlier on after July data showed that the Chinese economy was losing momentum amid slowing global growth.

Japan maintains interest rates but downwardly revised GDP growth forecasts

Flash estimates showed that the Jibun Bank Composite PMI reading for Japan fell to 48.9 in August, from a final 50.2 in the previous month. This was below expectations and signalled the first contraction in private sector activity since February. Retail sales for June increased 1.5% year-on-year, missing the market consensus of 2.8%. Japan posted a trade deficit of ¥1.43 trillion in July, compared to a surplus of ¥434 billion over the same period a year ago. This was slightly worse than the estimated gap of ¥1.41 trillion. The unemployment rate was unchanged at 2.6%, compared to the forecasted rate of 2.5%. As previously noted, the Bank of Japan (BoJ) maintained its key short-term interest rate at -0.1% and reiterated its target for the 10-year government bond yield at ~0%. The bank, however, has cut its 2022 GDP growth forecast by 50 basis points down to 2.4%, citing a slowdown in global economies and prevailing supply chain issues due to the war in Ukraine. Policymakers have also asserted that the BoJ will not hesitate to take extra easing measures if needed.

In South Africa, data was mixed

The composite leading business cycle indicator rose by 0.4% month-on-month in June, following a 0.7% decline in May. South Africa’s SACCI Business Confidence Index rose to 110.3 in July from 108.5 in June. It was the highest reading since March, helped by an increase in trade volumes and new vehicle sales. The seasonally adjusted Absa PMI Index decreased to 47.6 in July from 52.2 in June. It is the first decline in factory activity since July last year when the looting and unrest in KwaZulu-Natal hurt output. The S&P SA PMI rose to 52.7 in July from 52.5 in June, pointing to the fastest expansion in the country’s private sector activity since May last year. Private sector credit grew by 7.53% year-on-year in June after a 5.34% gain a month earlier. This marked the twelfth straight month of increase in private sector credit.

Retail trade decreased by 2.5% from a year earlier in June after a 0.1% uptick in the previous month and worse than market forecasts of a 0.4% rise. The trade surplus narrowed to R24.23 billion in June from an upwardly revised R30.85 billion in May. Exports rose 1.6% while imports rose at a faster 6.3%.

Mining production slumped by 8% year-on-year in June after a downwardly revised 7.2% fall in the previous month. It marks the fifth consecutive month of a downturn in mining activity, pressured by load-shedding and striking activity in the gold sector. Manufacturing production fell by 3.5% year-on-year in June after a downwardly revised 1.8% decrease in May.

Consumer price inflation accelerated to 7.8% in July from 7.4% in June, matching market expectations but above the South African Reserve Bank’s (SARB’s) target range of 3-6%. It was the highest reading in 13 years as prices continued to accelerate mostly for transport (fuel) and food. Core inflation, which excludes prices of food and energy, rose to 4.6% in July, the highest since October 2017, from 4.4% in the previous month.

The unemployment rate was at 33.9% in quarter two of 2022, better than expected and an improvement from the 34.5% print in quarter one of 2022. Employment rose by 648 000 to 15.562 million and the labour force went up by 780 000 to 23.556 million. The youth unemployment rate, measuring job seekers between 15 and 24 years old, also fell to 61.4% in quarter two of 2022, the lowest in almost two years.

There was no SARB meeting in July. The next one is in September.

OUTLOOK
Local

• Real economic activity is expected to soften from the elevated levels seen in 2021. Slower economic growth in Europe and China, as well as pressure on domestic household consumption from higher inflation, will contribute to this trend. Loadshedding is also a negative factor when it comes to real economic activity and economic growth.
• There are signs that progress is being made with the government’s economic reform programme. These include the liberalisation of energy production up to 100MW, private sector involvement in Transnet and Ports, and the successful completion of the 5G spectrum auction.
• In recognition of the country’s new energy crisis response, we have incorporated some improvement in business confidence starting from the current quarter.
• We have also meaningfully lifted private sector investment assumptions. These are positive developments that result in the real GDP forecast lifting towards 2% over the forecast horizon.
• The terms of trade boost seen in 2021, and a few other factors, have improved the fiscal outlook over the short-term, however, the longer-term outlook remains challenging. Fiscal pressures continue to be exacerbated by financial difficulties at SOEs, particularly Eskom.
• Domestic inflation remains high and is now expected to average 7% this year. Most of this inflation pressure is attributed to food and oil prices.
• Short-term interest rates are expected to increase from 6.50 to 6.75% by the end of the year on fears of higher inflation expectations.
• We expect the rand to continue enjoying some temporary relief before depreciating over the medium-term, within a wide trading range.
• Successful implementation of growth-enhancing economic and fiscal reforms represents an upside risk to our baseline view.

Global

• We remain cautious on the returns for global equity markets as the supportive monetary and fiscal policy that helped propel equities last year continues to fade.
• Hawkish rhetoric from the US Federal Reserve compared to other major central banks has helped increase the relative attractiveness of the dollar.
• Developed market consumption expenditure is expected to be more muted amid lower savings rates, subsiding government transfer payments, and as real disposable income is eroded by inflationary pressures.
• While supportive monetary and fiscal policy along with low relative valuations continue to support the investment case for Chinese equity. However, mixed economic data and further lockdowns due to the country’s zero Covid-19 policy are reasons to be cautious.
• The transition from stagflation to recessionary fears is starting to reflect in broader commodity prices as the global economy continues to slow.
• While price pressures remain sticky, we continue to believe that the US inflation profile will continue to subside in the second half of the year.
• While supply chain bottlenecks are still a concern, we continue to see signs that they are dissipating, which will create disinflationary pressures. Rising staple prices such as food and energy, as well as increases in the cost of borrowing will likely lead to lower inflation due to demand destruction.
• Inflation across the Eurozone and UK is rising faster than the US. Price pressures in these regions will likely be elevated for longer due to untenably high natural gas prices and other fuel costs, as well as meaningfully weaker currencies.