Market review

During this quarter there were some surprising MPC rate decisions and no real significant local political events. Also quite significantly the economy emerged from the technical recession which it experienced during 2016Q4 (0.3% contraction) and 2017Q1 (0.6% contraction) by growing 2.5% in 2017Q2.

At the SARB’s July MPC meeting it decided to cut the Repo rate by 25 bps from 7.0% to 6.75%, surprising most market participants. The decision was as a result of the SARB reducing its Core CPI forecast for 2017 through 2019 down to below 5.0%. At the end of July Moody’s stated that the rate cut will likely support economic growth. More importantly it also warned that the rate cut also signalled growing political pressure on the SARB, to which the market reacted negatively.

Following this, the SARB decided to keep the Repo rate unchanged at the September MPC meeting, again surprising the majority of the market. Contrary to the SARB’s more hawkish stance, the market was more dovish and growth oriented, considering that the economy just emerged out of a recession and that growth momentum is hard to pick up. The SARB stated that its assessment of the balance of risks to the inflation profile deteriorated from being “broadly balanced” to “be somewhat on the upside”. The Rand remains a key upside risk on continued vulnerability to political events, sovereign credit rating downgrades and a shift in global sentiment towards emerging markets. It is also at risk of faster than expected monetary policy normalization in the major developed markets.

SA’s fiscal strength continued to weaken as reflected by increasing budget deficits. Finance Minister Gigaba announced that the MTBPS (Medium Term Budget Policy Statement) will be 25 October. This will provide an updated forecast of fiscal slippage and will outline National Treasury’s response in terms of possible tax increases and expenditure cuts.

On the local political front, the unsuccessful vote of no confidence by secret ballot against President Zuma and the rejection of the Public Protector’s attempt to change the SARB’s constitutional mandate were of some significance.

In the US the Federal Reserve left rates unchanged over the quarter as a consequence of soft inflation and weak labour market conditions. During September the ongoing conflict between the US and North Korea and the extreme weather weighed against the Dollar providing support for emerging market currencies. With these events subsiding and the August US inflation printing 1.9% (up from 1.7%) the Dollar rallied strongly towards the end of the month. The Fed also indicated that it will start its balance sheet reduction, but it will be done in a gradual manner with noactive sales, just maturity run-offs.

CPI YOY in August improved to 4.8% from 5.1% in June. PPI YOY weakened to 4.2% in August from 4.0% in June. The USDZAR weakened to 13.54 from 13.06 during the quarter. The 10 YR SA government bond strengthened to 8.69% from 8.87% over the quarter. The trade balance declined to 5.94bn in August from 10.56bn in June.

The MM yield curve shifted down over the quarter as a result of the surprising 25 bps rate cut in July. It also flattened somewhat because the market is pricing in a further rate cut.

What we did
All maturities were invested across the money market yield curve, exploiting the term premium. Quality corporate credit, which traded above the 3 month JIBAR rates, was added to the portfolio. We preferred a combination of floating rate notes (FRN’s) in the portfolio together with some fixed rate negotiable certificates of deposits (NCD’s). The combination of corporate credit, high yielding NCDs and FRNs will enhance portfolio returns.

Our strategy
Our preferred investments would be a combination of fixed rate notes, floating rate notes and quality corporate credit to enhance returns in the portfolio. We are taking a balanced approach between fixed and floating instruments, considering current relative valuation, also that there could still be a rate cut or two and the upside risk to the inflation profile.

Market review
The SA interest rate market and currency had a roller-coaster ride this quarter,.. which was mainly driven by politics and global market sentiment.

Locally, on the political front, the quarter kicked off with President Zuma announcing.. that defiant ministers and government officials could be fired. This sparked.. uncertainty again regarding the finance minister’s post. Little did we know then that.. towards the end of the quarter when the finance minister and his entourage were on.. an international roadshow marketing the country, they would be recalled and.. eventually fired. Together with this a number of changes were also made to a.. number of other cabinet posts.

In the US, President Donald Trump announced travel restrictions from seven Muslim.. -majority countries. This had a negative effect on emerging markets. The travel ban.. was later overruled by a federal judge. Later in the quarter the Trump Administration.. also tried to replace Obamacare with Trumpcare. Just before the voting was going to.. take place, the Trumpcare bill was withdrawn.

In the UK, earlier in the quarter, the first attempt at triggering Article 50 was.. unsuccessful. Right at the end of the quarter Article 50 was triggered once more and.. the two-year Brexit negotiations were officially started.

National Treasury announced that a budget deficit of 3.4% is expected for 2016/2017 and expected gross domestic product (GDP) and inflation for 2017 is.. 1.3% and 6.4% respectively. An additional R28 billion in tax revenue will be raised in.. 2017/2018. This will be done with a combination of tax adjustments including a 45% tax bracket for income in excess of R1.5 million, restricted fiscal drag, a general fuel.. levy increase, excise duty increases and higher dividend withholding tax.

Locally, with inflation improving over the quarter, the South African Reserve Bank.. kept the repo rate unchanged at 7%. It also made downward adjustments to 2017.. and 2018 Consumer Price Index (CPI) forecasts (2017: 5.9% from 6.2% and 2018:.. 5.4% from 5.5%). In the US, the Federal Reserve raised interest rates by 25 basis.. points during its March meeting. Surprisingly, the US dollar weakened after this. The.. reason for this is that Fed Chair Janet Yellen’s speech was more dovish (less.. hawkish) than expected.

The year-on-year CPI improved from 6.8% in December 2016 to 6.3% in February.. this year and the Producer Price Index (PPI) from 7.2% to 5.6%. The rand.. strengthened from 13.73 to 12.30 against the dollar and finished the quarter at 13.40.. as a result of the cabinet reshuffling. The 10-year SA government bond yield had a.. similar story, starting at 8.92% and strengthening to 8.35% before weakening to.. 8.89% at quarter end.

The money market yield curve effectively flattened a little over the quarter, that is,.. longer rates/yields (up to five years) decreased more than shorter yields. If not for.. the cabinet reshuffling, the flattening would have been more, and one could then.. argue that some chance of a future interest rate decrease could be priced in.

What Satrix did
All maturities were invested across the money market yield curve, exploiting the.. term premium. Quality corporate credit, which traded above the three-month.. Johannesburg Interbank Agreed Rate (JIBAR), was added to the portfolio. We preferred a combination of floating rate notes (FRNs) in the portfolio together with.. some fixed-rate negotiable certificates of deposit (NCDs). The combination of.. corporate credit, high-yielding NCDs and FRNs will enhance portfolio returns.

Satrix strategy
Our preferred investments would be a combination of fixed-rate notes, FRNs and.. quality corporate credit to enhance returns in the portfolio. The money market yield.. curve is still steep and we will continue to make use of the curvature by maximising.. term in the portfolio.