Market Overview
Global markets lacked direction in May as investors remained concerned about global growth, rate hikes, sticky core inflation numbers and negotiations surrounding the US debt ceiling. The US market was able to carve out marginal gains on the back of a robust performance by large-cap tech counters, while European equities delivered a lacklustre performance. Chinese equities came under severe pressure following a series of economic releases, which fell short of expectations. The JSE also ended in negative territory as ongoing idiosyncratic risks continued to weigh on both local and foreign flows into the market.
The US interest rate outlook remained in the spotlight, with the commentary at the US Federal Reserve's May meeting suggesting that a pause may be considered - US Fed Chair, Jerome Powell, noted that the Fed is "getting close to or may even be there" with relation to the current tightening cycle. US inflation fell from 5% in March to 4.9% in April, the lowest reading since April 2021. Core inflation also trickled lower to 5.5% (prior: 5.6%) but remains stubbornly high and well above the Fed's target of 2%. Concerns over the country's debt ceiling (a legislative cap on the amount of debt that the US government is authorised to borrow) also added to the turmoil, however, a tentative agreement reached between President Joe Biden and House speaker, Kevin McCarthy, helped to temporarily alleviate market pressure towards month end. The S&P 500 had gained ~1% for the month at the time of writing. This was mainly driven by a rally in the tech sector, particularly among counters with strong demand for generative AI.
Moving across the pond, the European Central Bank (ECB) raised its key interest rates by 25bps (in line with expectations) during its May meeting - slowing the pace of policy tightening. Borrowing costs are now at their highest level since July 2008, following seven consecutive rate increases. The ECB continues to battle high inflation in the region despite a continued slowdown in economic activity, with ECB President, Christine Lagarde, confirming that the committee has more ground to cover and does not plan to pause lifting rates anytime soon. The EURO STOXX 600 was relatively flat for the month of May.
The JSE continues to face stifling idiosyncratic risks with the All Share giving back around 2% for the month. The rand came under additional strain recently with the general risk-off mood globally being amplified by SA-specific risks (including load-shedding) and the resulting impact on the country's growth prospects. The currency reacted sharply to allegations by the US ambassador to South Africa that the country loaded arms onto the Russian vessel, Lady R, in November. Meanwhile, the South African Reserve Bank's (SARB) Monetary Policy Committee (MPC) increased the repo rate by 50bps to 8.25% at its May meeting. The SARB also upwardly revised its headline and core CPI inflation forecasts, citing higher global inflation, domestic risks including high administered prices, food inflation and the cost of load-shedding. The 50-bps increase did little to alleviate pressure on the local currency. Interestingly, the MPC has reassessed the monetary policy stance as being restrictive, which could indicate that we have reached the peak of the hiking cycle (baring any further shocks).
Economic data overview
US inflation continues to taper downwards, however, core CPI remains sticky
Flash estimates showed that the S&P Global Composite PMI for the US increased to 54.5 in May 2023, from a final reading of 53.4 a month before. This signalled the fastest pace of expansion in the country's private sector since April 2022, as service sector growth was accelerated by stronger demand conditions. Retail sales for April increased 1.6% y/y, higher than expectations (1.4%). In March, the trade deficit narrowed to $64.2 billion, compared to forecasts of $63.3 billion, as imports climbed at a slower pace than exports. The unemployment rate in April edged down 3.4%, lower than market expectations of 3.6%. Annual inflation slowed to 4.9%, the lowest since April 2021, and below market forecasts. The Fed raised rates by 25bps in May 2023, as expected, marking the tenth increase and bringing borrowing costs to their highest level since September 2007. Fed officials expressed uncertainty about how much more policy tightening may be appropriate and focused on the need to retain optionality. Members agreed that, in assessing the appropriate stance of monetary policy, they would continue to monitor high-frequency data and would be prepared to adjust it as appropriate.
ECB members maintain a hawkish stance in order combat high inflation levels
On a preliminary basis, the HCOB Eurozone Composite PMI decreased to 53.3 in May, compared to 54.1 a month before. This was below expectations of 53.7. Retail sales in March were down 3.8% y/y, compared to forecasts of a 3.1% decline. A trade surplus of €25.6 billion was recorded in March, compared to forecasts of a $12.7 billion deficit, as exports rose 7.5% and imports fell 10%. The unemployment rate decreased slightly to 6.5%, slightly below market estimates of 6.6%. Consumer price inflation for April came in at 7%, slightly higher than the previous months reading of 6.9%. The ECB raised its key interest rates by 25-bps during its May meeting,as expected, signalling a slowing pace of policy tightening. Borrowing costs have now reached their highest level since July 2008, following seven consecutive rate increases as the ECB strives to combat high inflation despite ongoing recession risks. Additionally, President Lagarde told a news conference that the ECB had more ground to cover, and it was not pausing the rate-lifting cycle anytime soon.
The Bank of England continued to raise rates and remains open to further tightening if needed
Initial reports showed that the S&P Global/CIPS UK Composite PMI fell to 53.9 in May, missing market expectations of 54.6. Retail sales volumes decreased 3% y/y in April, compared to forecasts of a 2.8% drop. In March, the trade deficit shrank to £2.86 billion as exports dropped 1.2% and imports declined 1.8%. Slightly ahead of market expectations, the unemployment rate increased to 3.9%. Annual inflation in the UK fell to 8.7% in April, still exceeding market expectations. The Bank of England raised the bank rate by 25bps in May 2023, marking the twelfth consecutive rate increase, in line with market expectations. Policymakers added that they will continue to monitor indications of persistent inflationary pressures, including labour market conditions, wage growth and services price inflation. If there were to be evidence of more persistent pressures, then further tightening in monetary policy would be required.
Generally softer than expected numbers out of China raised some concerns
China's composite PMI declined to 53.6 in April, from 54.5 a month before. It was the fourth straight period of growth in private sector activity as services activity-maintained momentum following the removal of strict pandemic measures. Retail sales expanded 18.4% y/y in April but missed market consensus. Better than market forecasts, the country's trade surplus widened to $90.2 billion in April, compared to $49.5 billion over the same period a year ago, as exports rose 8.5% and imports unexpectedly dropped by 7.9%. The surveyed urban unemployment rate declined to 5.2% in April. China's annual inflation rate unexpectedly fell 0.1% in April, below consensus of 0.4%. This was the lowest print since a deflation in February 2021, with prices of both food and non-food easing further.
Inflation in Japan came in higher than expected; however, policymakers kept rates unchanged
Early estimates showed that the Jibun Bank Composite PMI reading in May rose to 54.9. This was the fourth straight month of growth in private sector activity, the steepest pace since October 2013, and the second strongest in the survey history, as a recovery from pandemic disruptions gained momentum. Retail sales for March increased 7.2% y/y, exceeding market consensus of a 5.8% gain. Japan's trade deficit fell to ¥432.4 billion in April, compared to ¥"854.9 billion in the same month last year. This was less than the estimated gap of ¥613.8 billion. The unemployment rate was unexpectedly lower at 2.6%, less than market consensus of 2.7%. Annual inflation rose to 3.5% in April, above consensus. The Bank of Japan (BoJ) kept its key short-term interest rate unchanged, in line with market expectations, but modified guidance on its policy rate by removing reference toward the need to guard against risks from the Covid-19 pandemic and to keep interest rates at "current or lower levels".
In South Africa, inflation fell to an 11-month low but remains above the upper limit of the SARB's target range of 3% to 6%
In March 2023, the SACCI business confidence index dropped to a four-month low of 111, while the leading business cycle indicator fell 2%, as rampant load-shedding and high interest rates continued to weigh on the outlook. The composite PMI decreased to 49.6 in April (March: 49.7), amid a sustained downturn in private sector activity. Manufacturing PMI, however, rose to 49.8 from 48.1 a month before. Retail sales in March contracted 1.6% y/y, reflecting the elevated cost of living for consumers. This was worse than market expectations of a 0.7% decrease. SA recorded a trade surplus of R6.9 billion in March. This was below expectations of R25 billion as imports surged 31.7%, while exports advanced at a slower 26.9%. The value of recorded building plans passed in SA's larger municipalities dropped 18% y/y, following an upwardly revised increase of 12.7% a month before. Mining production was down 2.6% y/y in March, compared to forecasts of a 5% drop. This followed an upwardly revised slump of 7.6% in the previous month. Manufacturing production edged 1.1% lower, signalling a fifth consecutive month of decreased industrial activity. Nevertheless, this decline was better than expectations (-6.1%).
CPI dropped to an 11-month low of 6.8% in April (consensus: 7%). This remains well above the SARB's target range of between 3% and 6%. Core inflation (which excludes the price of food and energy) rose to 5.3%, as expected. Producer price inflation (PPI) slowed to 8.6%, compared to 10.6% a month before. This was also well below expectations. Due to the significant depreciation of the rand and the mounting pressures of inflation, the SARB implemented another 50bps rate hike during its May meeting, bringing the benchmark interest rate to 8.25%. This was the tenth consecutive rate hike since policy normalisation began in November 2021, bringing borrowing costs to their highest levels since May 2009. Headline inflation for 2023 is expected at around 6.2% (previously: 6%).
Market Outlook in a nutshell
Local
Global
Where to for the struggling rand?
The rand began depreciating a few of weeks ago, with general risk-off sentiment globally amplified by South Africa (SA)-specific risks including the impact of load-shedding on the country's growth prospects. The weakening bias was entrenched following a sharp reaction by the currency to allegations by the United States ambassador to South Africa that the country loaded arms onto the Russian vessel, Lady R, in November.
A 50-basis point increase in interest rates by the SARB did little to temper the weakening bias - and in fact saw the local currency weaken even further. The reaction was surprising given that higher interest rates generally support exchange rates. It could be that the currency reacted to the "outlook" for rates (being that we could be at the peak); or that the market was hoping for a more aggressive increase to respond to a much weaker rand; or that the increase could stifle growth further.
On Tuesday, 30 May, the rand made a new intra-day all-time high against the US dollar of 19.87. In the last couple of weeks, we have also seen the weakest daily and weekly closes on record.
The violent move in the rand this month has prompted many investors to consider "what's next" for the rand and the associated implications for asset allocation decisions.
At the start of the month, our houseview was for the rand to average R17.70 to the US dollar for the year. Year-to-date, the currency has averaged R18.09 to the US dollar. We would expect sentiment to continue to dominate movements in the short term - particularly as South Africa navigates a complex geopolitical environment through August at least (the BRICS summit), and as loadshedding remains elevated through the winter months. However, the currency has moved well beyond "fair value" territory, which means that we could expect strength in the rand medium term.
Our near-term fundamental view is also supported by the technicals. The rand remains above its 200-day simple moving average against the US dollar, a major psychological level, and momentum is strongly upward. This means that the trend still favours sustained weakness. That said, a reading of 70 on the Relative Strength Index (RSI) indicates that rand weakness may be overdone. This means that a correction (strengthening) may be on the cards.
While it is difficult to speculate over a possible catalyst for rand appreciation, valuation may begin to play a role - both on the currency front and for SA assets, which look undemanding on a relative basis. A post-winter improvement in the outlook for the electricity shortfall and hopefully a tempering of geopolitical factors, may also see sentiment better. Finally, a general improvement in risk sentiment globally will also be supportive of riskier assets (like SA bonds and equities) and may prove to be a catalyst. This sentiment shift could be catapulted by several events including the US skirting recession, China growth coming through strongly,inflation coming down more than expected (which means a pause in rate hikes), or growth disappointing and pulling forward potential interest rate cuts.
From an asset allocation perspective - for long-term investors, as mentioned above, domestic risk assets seem to be offering decent value currently (both SA Inc equities and bonds) and, despite the likelihood that the rand will remain weak near term, it is likely not the best time to sell rands (i.e., to take money offshore) when the rand is this weak.
Disclaimer: All figures have been obtained from Bloomberg based on each company's latest financial results. Companies disclose degrees of geographic exposure in varying granularity, which may cause discrepancies, and figures obtained may be impacted by currency volatility and may not be representative of future exposures.
For more information regarding your investment, please contact your Portfolio Manager directly.
Regards
FNB
