Sanlam Select Strategic Income comment - Sep 19
It wasn’t more than a year ago that US Federal Reserve (Fed) Chairman Jerome Powell was praising robust employment figures, strong consumer and business investment and strengthening economic activity. Counter to this, at the turn of the year we were clear on our view of a late-cycle scenario with global growth slowing towards and even below 3%. This view remains firmly entrenched and given recent issues in Germany and China it is even possible we see a more meaningful dip sub 3% in coming quarters. Germany, on the brink of a technical recession, is particularly starting to take strain on the consumer front and seems very reluctant to move on fiscal stimulus. The Chinese – finding itself in a slightly similar situation, and importantly still under pressure from relentless US attacks – are unlikely to repeat broad-based stimulus measures that bailed out the global economy in 2012 and 2016. In the absence of stimulus from these two major economies, the catalyst for an upside surprise to global growth seems missing.
While we expected global central banks to lower interest rates in 2019 and into 2020, recent reluctance in this regard perhaps speaks to the runway for monetary support running out. Post Jackson Hole in August it has become clear that monetary authorities are putting pressure on fiscal support to kick in, with the European Central Bank in particular being firm in this regard. The September Fed dot plot made clear the split in opinion not only on the strength of the US economy, but also the outlook for the global economy. This uncertainty is also tangible in global sell-side research, with the likes of BNP calling for up to five US interest rate cuts between now and mid-2020, while other global strategists suggest the Fed is already erring by lowering interest rates. As one strategist put it:
‘Credit spreads are back in line with long-term averages. The VIX is trading in the lowest decile of its long-term range. Beyond financial valuations, and despite a flurry of negative sentiment indicators, the US unemployment rate fell to 3.6% in 2Q19 – a cyclical low. Average hourly earnings are increasing by over 3% y/y, while inflation, adjusted for food and energy, printed at 2.1% y/y in July. Consumer confidence, as measured by the University of Michigan Consumer Sentiment Index, is also near a decade high.’
Much hinge on the outcome of ongoing trade disputes between the US and other economies, but in particular China. It is instructive that the Democrats are once again trying to have President Trump impeached.
Broadly speaking we have been looking for the Dollar to trade in a $1.10-1.18 range, the US 10-year bond to only briefly dip below 2% and oil prices to average around the $55-60 mark. Clearly the $1.10 mark on the Dollar is now firmly on everyone’s radar (as is 100 on the US Dollar Index), but with regards to bond levels a major change in 2019 is the arrival of negative bond yields once again – at its peak in the third quarter this year we had almost $17 trillion of global bonds trading with a negative yield to maturity.
As we approach year-end, the above global risks (we have also since our last comment had oil field attacks in Saudi Arabia) will amplify nerves in the local economy.
For the time being the catalysts for a meaningful weakening in the US Dollar seem absent. Oil markets seem roughly balanced, with two-sided risks around $60 still. US Treasuries, together with all developed market bond yields, seem very expensive, but with equity markets still hovering around record levels, where should investors look to? Markets seem to be pre-empting the re-introduction of quantitative easing, explaining the recent sharp rally in the rates market.
When this comment is published, we will likely (if the year-to-date trend of promising updates but not delivering on it had changed) know whether the ANC supports the recently released National Treasury economic paper, and likely also have had sight of the much-touted Eskom white paper. (I don’t count the post-NEC comments to constitute anything firm.)
We are therefore writing this comment in the absence of information on critically important pieces of information. It is our opinion that the ongoing silence from government regarding whether it supports the Treasury’s paper explains the recent reversal of fortunes of the local market.
While the reason for shifting the date of release of the Medium-Term Budget Policy Statement (MTBPS) from 23 to 30 October 2019 is not known, the outcome of the MTBPS is already expected to be much worse than that of the previous MTBPS as well as the 2019 National Budget. Strategists seem to have consensus that the deficit will be wider than 6%, 2% worse than expected a year ago, with debt/GDP now seen well over 60%. While issuance isn’t necessarily seen increasing further –with National Treasury announcing a very big increase in August, as well as announcing a successful $5 billion offshore issue (at eye-watering levels!) – in the absence of improving revenue the issuance burden on South Africa seems on a one-way track towards meeting its maker.
It seems a fait accompli that unless government comes out in at least partial (but we can only hope full) support of the National Treasury paper, and if there is indeed truth to the $11 billion green funding solution for Eskom, Moody’s should move the outlook on the sovereign to negative on 1 November 2019. Although this is not the end of the road for the sovereign, it is no doubt a slippery slope towards a downgrade and exit from the World Government Bond Index.
The time has come for government to step up to the plate and not only talk about reform but put words into practice. And if you don’t want to take our word for it, then how about this.
The following excerpt is from a media release by Cas Coovadia, MD of the Banking Association of South Africa:
‘The National Treasury discussion document – Economic transformation, inclusive growth and competitiveness: Towards an Economic Strategy for South Africa – is an important contribution to the development – and urgent implementation – of a pragmatic economic recovery plan for the country.
The Banking Association South Africa (Basa) supports the proposed strategy.
We appreciate the opportunity – given to all South Africans – to contribute to the discussion document. It is a welcome departure from the normal policy-making processes of the government and the governing party.
Economic policy affects the quality of life of all South Africans and cannot be the sole preserve of the governing party and its allies, especially given the last nine years of state capture, low economic growth, corruption and maladministration.
Today South Africa has a depleted fiscus, debilitating unemployment, poverty, inequality and dangerous levels of social instability. The discussion document speaks to the realities of the economic crisis facing our country and the urgency with which it must be addressed – without narrow political or ideological considerations.
We urge the president of South Africa, Cyril Ramaphosa, to take ownership of – and responsibility for – the strategy and hold his ministers accountable for its implementation. Without brave, committed political leadership, these proposals cannot succeed – and neither will our country.’
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