Market overview

Market overview

Global markets took a step back in February, partially offsetting the upward momentum seen at the start of the year. This came as headlines were dominated by a plethora of robust economic data out of the United States (US) which fuelled expectations for the US Federal Reserve (Fed) to remain on the offensive in terms of its monetary policy. The Johannesburg Stock Exchange (JSE) was not immune to the risk-off environment globally, with several idiosyncratic risks placing further barriers on foreign interest in the local market.

Market Overview Table Feb 2023

Stronger-than-expected economic data suggested that the US economy is a lot more resilient than initially anticipated which reignited expectations for the Fed to remain hawkish for a longer period. Inflation, which remains well above the Fed’s 2% target, also slowed by less than expected in January. This led to a swift change in the market mood – “terminal rates” were upwardly revised with expectations for a pause or an easing in monetary policy being pushed further out. Traders are now pricing in US rates peaking at 5.4% this year compared to expectations of less than 5% a month ago. Equity markets came under pressure with the S&P 500 trading down ~2% towards month end.

Geopolitical tensions between the US and China created additional headwinds, weighing on the initial rally seen in January following the re-opening of the world’s second-largest economy. In terms of performance, the MSCI China Index and the Hang Seng Index gave back over 13% and 12% respectively during the month. European markets, however, performed well as the region maintained positive momentum out of January’s bull run. This was underpinned by a milder-than-expected winter, easing energy prices and expectations for a much shallower recession than anticipated.

Sentiment towards emerging markets took a hit in February and South Africa (SA) was particularly out of favour due to significant idiosyncratic risks (i.e., unprecedented levels of load-shedding and ongoing political turmoil surrounding Eskom and its executive members, as well as the recent greylisting by the Financial Action Task Force) which also resulted in the rand weakening to around of R18.45 against the US dollar. Investors also kept a watchful eye on the local budget speech which was once again market-friendly, offering some temporary relief. More recently, news that the US could reconsider its relationship with SA over growing ties with China and Russia added to investor concerns. The All Share Index gave back 4% for the month and was down 10.5% in US dollar terms.

Both local and offshore bonds also pulled back due to shifts in global sentiment.

Economic Data Review

US slowed by less than expected in January with robust economic data fuelling rate hike expectations

Flash estimates showed that the S&P Global Composite Purchasing Managers’ Index (PMI) for the US increased to 50.2 in February 2023, from a final reading of 46.8 a month before, signalling broadly unchanged output across the private sector, helped by a marginal increase in service sector output and a slower decline in manufacturing production. Retail sales for January increased 6.4% year-on-year, better than expectations (5.9%). In December, the trade deficit widened to $67.4 billion, compared to forecasts of $68.5 billion. The unemployment rate in January dropped to 3.4%, below market expectations of 3.6%. Annual inflation was confirmed at 6.4%, the lowest since October 2021, but above market forecasts of 6.2%. Almost all Federal Open Market Committee participants agreed that it was appropriate to raise the target range for the federal funds rate by 25 basis points (bps) at the first monetary policy meeting of 2023 (as expected), although a few officials favoured raising it by 50bps. All participants continued to anticipate that ongoing increases would be appropriate until data provided confidence that inflation was on a sustained downward path. 

The European Central Bank (ECB) remains focused on returning inflation back to target rates

On a preliminary basis, the S&P Global Eurozone Composite PMI increased to 52.3 in February, compared to 50.3 a month before. This was above expectations of 50.6. Retail sales in November were down 2.8% year-on-year, compared to forecasts of a 2.7% decline. A trade deficit of €8.8 billion was recorded in December, compared to forecasts of a $12.5 billion deficit, as imports climbed 8.7% year-on-year, while exports rose 9% year-on-year. The unemployment rate was unchanged at 6.5%, in line with market estimates of 6.5%. Consumer price inflation for December came in at 9.2%, slowing from 10.1% a month before. The ECB raised interest rates by 50bps in February, in line with market consensus. The ECB governing council member Gabriel Makhlouf has said in an interview with the Wall Street Journal that the bank could increase interest rates above 3.5% and isn't likely to cut them again this year as the institution moves forcefully to bring inflation back to target. Makhlouf has previously said he would not be surprised if policymakers kept raising interest rates beyond the end of March.

United Kingdom (UK) inflation eases but remains high – market participants now await further commentary from the Bank of England (BoE)

Initial reports showed that the S&P Global/CIPS UK Composite PMI increased to 53 in February, above market expectations of 49. Retail sales volumes decreased 5.1% year-on-year in January, compared to forecasts of a 5.5% drop. In December, the trade deficit stood at to £7.2 billion as imports rose 2.2% and exports slumped 4.3%. In line with market expectations, the unemployment rate was unchanged at 3.7%. Annual inflation in the UK eased to 10.1% in January, below market forecasts. The BoE raised interest rates by 50bps during its February meeting, pushing the cost of borrowing to the highest level since late-2008. It was the 10th consecutive rate hike amid policymakers' efforts to combat high inflation and came despite an expected recession this year. Meanwhile, the central bank dropped its pledge to keep increasing rates "forcefully" if needed and said inflation had probably peaked, suggesting it might start reducing the pace of rate increases soon.

Data out of China was positive with prospects remaining promising following the reopening of the economy in January

China’s composite PMI rose to 51.1 in January, from 48.3 in December. It was the first growth in private sector activity since last August, buoyed by the removal of harsh pandemic measures. Retail sales dropped 1.8% year-on-year in December, significantly better than the expected 8.6% decrease. Better than market forecasts, the country’s trade surplus decreased to $78 billion in December, compared to $93.2 billion over the same period a year ago, as exports and imports fell 9.9% and 7.5%, respectively. The surveyed urban unemployment remained unchanged at 5.5% in December. Inflation rose to 2.1% in January, which was below expectations. This was the highest reading in three months, as prices of food jumped and those of non-food gained further on the back of the Lunar New Year festival and the removal of pandemic measures.

Inflation continues to rise in Japan, placing further pressure on the Bank of Japan (BoJ)

Early estimates showed that the Jibun Bank Composite PMI reading in February was unchanged at 50.7, marking the second consecutive period of expansion amid widely differing trends in the manufacturing and service sectors. Retail sales for December increased 3.8% year-on-year, exceeding market consensus of a 3% gain. Japan’s trade deficit widened to ¥3.5 trillion in January, compared to ¥2.2 trillion in the same period a year ago. This was better than the estimated gap of ¥3.8 trillion. The unemployment rate was unchanged at 2.5%, in line with forecasts. Annual inflation climbed to 4.3% in January, slightly higher than consensus (4.2%). This was the highest reading since December 1981, amid a rise in prices of imported raw commodities and yen weakness. During its January meeting, the BoJ maintained its key short-term interest rate at -0.1%, as expected. The BoJ reiterated it would take extra easing measures if needed while expecting short-and long-term policy interest rates to stay at their present or lower levels.

In SA, inflation continues to trend downwards, however, load-shedding, and political headwinds remain a concern

The SACCI Business Confidence Index dropped to 112.9 In January 2023 (December 2022: 117.3), due to the adverse impacts of load-shedding on day-to-day activity. Composite PMI fell to 48.7 – the first downturn in private sector activity for over three months. Manufacturing PMI, however, was unchanged. In December, the leading business cycle indicator declined 2.1% month-on-month.

Retail sales in December contracted 0.6% year-on-year, slightly worse than expectations for a 0.1% drop, with pharmaceutical and personal goods retailers the largest detractors to growth. The trade surplus dropped to R5.4 billion (forecasts: R5.5 billion) driven by a 5.1% slump in exports amid reduced shipments of base metals, machinery & electronics, and chemical products. The value of recorded building plans passed fell 11.5% year-on-year, following an upwardly revised surge of 13% a month before.

Mining production was down 3.5% year-on-year in December, following an upwardly revised drop of 9.2% in the previous month. This was, however, better than expectations (-6%). Manufacturing production decreased 4.7% year-on-year, significantly worse than expectations (-2.5%).

Consumer price inflation eased for a third straight month to 6.9% in January. This was in line with expectations but still above the South African Reserve Bank’s (SARB) target range of between 3% and 6%. Core inflation (which excludes the price of food and energy) stood at 4.9%. Producer price inflation dropped for a sixth consecutive month to 12.7%, slightly below forecasts.

At its January meeting, the SARB raised its benchmark repo rate by 25bps to 7.25%, in contrast to market forecasts of a 50bps hike. This was the eighth consecutive rate hike since policy normalisation began in November 2021, to anchor inflation expectations more firmly around the mid-point of the target band (~4.5%). The SARB expects to achieve its inflation target by 2024.

 

Outlook

Local

  • Weaker global growth and load-shedding cloud the growth outlook for 2023. While the global slowdown is proving less pronounced than what was expected at the end of 2022, the outlook on local electricity shortages has worsened with higher stages of load-shedding becoming the norm.
  • Furthermore, a higher intensity of load-shedding has lifted the cost of doing business which should be exacerbated by more onerous due diligence on foreign transactions following South Africa’s greylisting. These factors should also impact confidence across the economy and worsen risk sentiment towards the country.
  • Nevertheless, the interventions announced in the 2023 Budget, solar incentive for households and business as well as Eskom’s debt relief, should assist in incrementally reducing the energy constraint. Importantly, only a stern commitment to achieving structural reform in energy and other network industries will support a lift in business confidence, private sector investment and more robust economic growth. As things stand, gross domestic product (GDP) growth is expected to average 1.5% in the medium term – insufficient to alleviate unemployment.
  • Slower economic growth, a stymied employment recovery, weaker confidence and an elevated cost of living should drag on household consumption, accounting for over 60% of GDP, with consumers being pushed to spend more on essentials.
  • Unfortunately, cost of living pressures could dissipate slower as the lift in the local cost of doing business adds to elevated global inflation. The International Monetary Fund (IMF) expects global inflation to ease from 8.8% last year to 6.6% in 2023 and 4.3% in 2024 but to remain well above the pre-pandemic average of around 3.5%. This as escalated geopolitical tensions lift trade fragmentations, while the cleaner economy drive adds to market friction. In line with this and a higher local cost of doing business, we anticipate headline inflation of 5.8% this year, averaging over 5% over the medium term and remaining above the SARB’s preferred anchor of 4.5%.
  • Short-term interest rates are expected to increase to 7.50% in 1Q23. Upward pressure on interest rates includes a higher peak in the policy rates of key advanced economies, more adverse risk sentiment, the rand continuing to be weighed on by idiosyncratic risk, and stickier local inflation. Overall, there is a stronger likelihood that interest rates will remain elevated for longer.
  • With Treasury remaining committed to fiscal consolidation, policy coordination appears intact. Risks to the fiscal outlook include stronger wage bill growth, exposure to poor state-owned enterprise performance and finding a sustainable replacement for the Social Relief of Distress grant. These risks cast doubt on how quickly and at what level government debt will stabilise.

Global

  • Our primary concern going forward is whether the resilience of company earnings can be extrapolated into the future. We believe that this may prove difficult as fiscal and monetary policy, particularly in the US, will likely be on a restrictive path. In particular, the lagged effect of tightening monetary policy actions will likely begin to filter through to changes in both corporate and consumer spending patterns.
  • Higher borrowing costs for both businesses and consumers will likely suppress economic activity, particularly in discretionary-related areas, as economic agents look to rein in expenditure to tighten their balance sheets and income statements. This, combined with lower savings rates, subsiding government transfer payments, and depressed real disposable income will likely erode demand.
  • At the moment, households will likely continue utilising various credit instruments, particularly credit card debt, which is currently at all-time highs, to prop up short-term expenditure prospects.
  • Despite an increase in the policy rate combined with balance sheet tightening from the US Federal Reserve, financial conditions have loosened meaningfully recently amid interest rate cuts being priced in by the futures market.
  • Our view at this juncture is that loosening financial conditions are unlikely to be sustained as we head in 2023 as the Fed will need to tighten financial conditions to bring inflation down to more sustainable levels; hence we maintain our strong dollar bias at this juncture.   
  • Chinese data has shown nascent signs of improvement relative to market expectations and mobility data is improving. It is encouraging to see Covid-19 cases well off their peak and notable monetary policy easing take place more recently. While we remain cautious of further haphazard policy pronouncements, we are constructive on the outlook for China.     
  • Once peak hawkishness of the Fed has been sufficiently priced in by market participants, and inflation is firmly on a downward trajectory, we will be looking to take a more explicit position on the long end of the bond curve. This will be to reflect a deterioration in growth dynamics that will begin to overshadow inflation fears. At this stage, we believe that the rate cutting cycle priced in by the futures curve is premature.