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Stagflation concerns have been fuelled by uncertainty as to whether the world is shifting away from globalisation, towards “slobalisastion” and trading blocks. The integrated supply chains of the past 20 years, characterised by efficiency gains, played a role in keeping inflation contained. Higher commodity prices and the movement of production facilities closer to end-users could lead to stickier inflation. Supply chains are again disrupted by lockdown restrictions in China. Monetary policy around the world is tightening to combat higher inflation at a time when growth is slowing down.
Inflation is expected to peak in the next six months but the question is whether inflation could return to the Central Banks’ targets or remain higher for longer.
Key focus points
- High level of geopolitical uncertainty
- Inflation could stay higher for longer
- Global growth forecasts have been revised down with downside risks
- Higher US demand/supply driven inflation and a more aggressive Fed
- Renewed concerns about Chinese growth prospects amid the zero-Covid strategy
- Energy crisis in Europe and cost-push inflationary pressures
- Global monetary policy is tightening but there is a divergence between the Fed and other G10 central banks such as the ECB and BoJ
- Market sentiment is negative.
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Russian war in Ukraine
- There is no clean ending in sight to the war. Growth forecasts assume the Russia-Ukraine crisis will continue for several months. Western sanctions on Russia are likely to stay in place for a considerable period of time.
- The knock-on effect throughout the rest of the world could translate into lower growth as a result of commodity price shocks, higher inflation and rising interest rates. The IMF lowered its April 2022 global growth estimates for 2022 (-0.8ppt) and 2023 (-0.2ppt) to 3.6% from the IMF’s January 2022 projections.
- President Biden requests $33bn more aid from Congress for Ukraine.
- Europe gets 40% of its natural gas from Russia, worth ~$800m per day. Russia has demanded payment for natural gas in RUB. Supply to Bulgaria and Poland has been shut down after they refused to make payment in RUB. Poland is no longer reliant on Russia for natural gas supply as LNG capacity has been built since 2010. Gas storage has been raised to ~60%. It is unclear how all of this will play out. Europe has threatened an oil embargo on Russia, and Russia in turn is threatening to retailiate by shutting down natural gas pipelines. Note that this a high risk scenario which could drive up gas prices. Europe needs to invest in more gasification by building new import terminals for liquefied gas, which could take years.
- The US economy unexpectedly contracted by 1.4%q/q (saar) in 1Q 22 vs expectations of +1.0%q/q and 6.9%q/q previously. The decline was driven by a large trade deficit due to strong demand for imports and softer inventory growth. Economic activity continues to be strong. (1) The level of growth was 3.6% higher than the same period in the previous year, (2) the underlying growth rate is above the potential growth rate of ~2.8%, and (3) the IMF forecasts GDP to grow by 3.7% and 2.3% in 2022 and 2023.
- The labour market continued its recovery in March and the total number of unemployed workers has declined to 5.9m compared with 5.7m pre-pandemic. The unemployment rate has receded to 3.6% from a high of 14.80% in April 2020 and 3.5% pre-pandemic.
- Labour costs continue to accelerate. The Employment Cost Index (ECI), which measures changes in employee compensation costs, rose by 4.5% in 1Q 22, the fastest pace since 2001.
- Acitvity in the housing market is sensitive to higher prices and interest rates. Median house prices have increased by 20.2%y/y in February (P: 18.9%) and 30yr mortage rate have risen to 5.1% from 3.11% at end 2021. Housing affordability has consequentely deteriorated to the lowest level since 2007.
- CPI inflation surged to 8.5% in March (P: 7.9%) and core CPI inflation (excluding food and energy) rose to 6.6% from 6.4%.
- Fed chair Powell signals the Fed funds could be raised by 50bps at the May FOMC meeting. Some participants are of the view that the FOMC could front load rate hikes even more aggressively, raising rates by 75bps at two of the next three FOMC meetings (May, June and July).
- The IMF revised the EU’s growth outlook down by 1.1ppts to 2.8% in 2022. Higher energy prices and lower energy security (which is leading to a negative terms of trade shock), is leading to higher inflation and lower output. Supply chain disruptions have intensified, i.e. in the auto sector. Real economic indicators show that the registration of new cars declined by 20.5% (P-6.7%).
- Sentiment in Europe has deteriorated sharply. PMI surveys in the Eurozone have weakened, with Germany recording the largest decline.
- CPI inflation for the region rises by 7.4% in March from 7.5% driven by cost-push pressures. Preliminary data for April shows CPI inflation in Germany rose by 7.8% from 7.6%.
- President Macron is elected in France for a second term with 58% of the vote.
- The ECB could end net asset purchases in July and raise rates by September.
- The outbreak of the Omicron variant and China’s zero-Covid strategy, which precipitated new mobility restrictions in March, have led to a significant weakening in economic activity in the past two months. Although GDP grew by 4.8%y/y in 1Q 22, ahead of expectations of 4.2%y/y, incoming indicators for retail sales, industrial production and fixed asset investment deteriorated in March. PMI indicators for April showed a decline in new and export orders. Shanghai has been in lockdown for five weeks. Bloomberg consensus expectations for 2Q 22 GDP has been lowered to 1.0%y/y from 1.5%y/y previously.
- Inflation remains muted with CPI inflation rising by 1.5% (P0.9%).
- The IMF lowered China’s GDP growth forecast by 0.4ppt to 4.4% in 2022. The zero-Covid strategy is expected to continue dampening consumer spending and employment creation in urban areas, as well as supply disruptions, investment growth in the real estate sector continues to be weak.
- Fear of US sanctions caused China to hold meetings with foreign domestic banks to examine measures to protect overseas assets.
- Damage caused by KZN floods and load shedding could moderate economic activity in 2Q 22. Incoming indicators for March 2022 painted an improved outlook for the economy. Load shedding hit a record high of 22 000MW of generation capacity in the second week of April, of which 17 000MW was unplanned. Eskom anticipated between 37 to 101 days of load shedding.
- Confidence in the manufacturing sector measured by Absa’s PMI accelerated to 60, raising the 1Q 22 average to 58.5 from 55 in the previous quarter.
- New vehicle sales increased by 16.5% from 18.4%, reaching the highest monthly sales number since the pre-pandemic month of October 2019.
- Household credit extension continued to strengthen, rising by 6.2%y/y from 4.6%, driven by demand for installment sales credit on unsecured loans. Corporate credit extension rebounded by 6.4%y/y (previously 3.4%), mainly owing to base effects. Overdrafts increased by R21.8bn, whereas general loans declined by R13.2bn over the month.
- The merchandise trade balance widened to R45.9bn from R11.5bn (revised from R10.6bn) as the value of exports grew by 30.9% to R141.9bn (owing to a rebound in mineral exports of R13.5bn) and precious metals (R19.4bn). This exceeded the increase in the value of imports of 7.3% to R140.0bn. In Q1 22, the trade balance amounted to R61.4bn compared with R96.2bn in the same period in 2021 and R92.5bn in 4Q 21.
- CPI inflation rises to 5.9% from 5.7% and core CPI inflation by 3.8% from 3.7%. PPI for final manufactured goods surged by 11.9% from 10.5%.
- Covid-19 infections begain to rise again, increasing to 6 000 last week. Hospitalisations remain low.
- Moody’s changed South Africa’s sovereign rating outlook from Ba2 negative to Ba2 stable.
- South Africa is ranked for the first time among the 10 least desirable of 84 global mining jurisdictions in the Fraser Institute's Mining Companies Survey of 2021.
- The SA government issues two new bonds in the international capital markets of $1.4bn (2032 at a spread of 309bps) and $1.6bn (2052 at a spread of 447bps).
- National Treasury announces a ‘Bounce Back Support Scheme’ for business. This consists of a R20bn guarantee loan through participating banks, DFIs and non-bank SMEs.
- The Zondo Commission delivered Part 4 of the state capture report to President Ramaphosa.
Fixed income markets, equities and currencies had a challenging month in the context of the high geopolitical uncertainty, downward revisions to global growth forecasts and a further repricing of Fed rate hike expectations.
- A divergence in monetary policy between the FOMC and BoJ and Chinese growth downgrades, with monetary policy also required to become more accommodative, caused large movements in the USD/JPY and USD/CNY. The BoJ remains super dovish and has announced unlimited amounts of bond purchases to keep the 10yr yield anchored at 0.25%.
- The USDJPY appreciates by 6.5% over the month to 129.70/USD, the highest level since April 2000.
- The USDCNY falls by 4.6% to CNH6.64/USD, the lowest level since November 2020.
- The Bloomberg USD index appreciates by 4.5% on account of more robust fundamentals, higher interest rates and geopolitical concerns, rising against G10 and EM currencies. This is the highest level since May 2020. The RUB is the only currency that strengthens more than the USD, increasing by 13.2% due to Russian demands for natural gas payments in RUB.
- The USDZAR appreciates by 7.5% owing to its sensitivity to Chinese growth and commodity prices. The ZAR’s trading range in April was R14.61/$ to R16.03/$. High beta currencies such as the ZAR came under significant pressure, weakening against cross currencies but less so than against the USD: CNY -3.5%, GBP -3.3%, EUR-2.9%, AUD -1.9% and JPY -1.4%.
Equities ended the month lower with MSCI for EM down by -7.7% and MSCI for developed markets -6.3%: Nasdaq -13.5%, Shanghai composite -7.2%, S&P -5.4%, Nikkei -5.0%, DAX -2.4%, JSE Top 40 -4.3% and JSE All share index -3.6%.
Commodity prices are mostly stable: The Bloomberg commodity index that includes 30 commodities ended 4.1% higher over the month. SA specific commodity prices (USD) were stable to marginally higher: Coal (+16.1%), palladium (+4.0%), gold (+2.5%), iron ore (+2.5%) and platinum (+1.9%). The price of rhodium recorded larger declines of 16.1% and 6.6%, respectively. Brent spot ended the month 0.1% lower at $107.1/$. The slate which determines the over/under recovery of the fuel price recorded an average overrecovery of nearly 15c/l. However, the rand depreciation during the month has caused yet another large daily underrecovery of 78c/l on the slate. The Department of Minerals and Energy sold R6bn of strategic oil reserves to finance the slate to keep the fuel price from rising by R1.50/l in April and May. South Africa’s terms of trade (Citi Bank index), however, has given up most of the gains recorded since late February and has reached the lowest level in 2022.
US interest rates: The implied Fed funds futures rate is projecting a total of 253bps of rate hikes by end 2022. The front loaded profile includes 50bps in May, a bias towards more than 50bps in June (+61bps), a further 50bps at each of the next two meetings in July (+48bps) and September (+42bps) and then followed by two more increases of 25bps each at the final two meetings in November (+22bps) and December (22bps). Of interest is that the spread between implied forward rates in 2023 and 2024 is -21bps. This shows that the concern of a US recession caused by a too aggressive rate hiking cycle could lead to an easing in monetary policy in 2024. The 10yr US Treasury yield rose to nearly 3.0% in April (2.93% from 2.33%). The increase in the yield was driven by a rise in the real yield, with the 10 year TIPS rate approaching zero (-0.03%), the closest to zero since March 2020, when the Covid-19 pandemic spread around the world.
- Government bonds and equities both yielded a negative return in April. The Albi declined by 1.7% and the FTSE/All share index 3.7%. Cash (as measured by the Stefi index) yielded a positive return of 0.4% and the ILB index a return of 1.9%, as real yields declined as investors hedged against higher inflation.
- The steepening of the SAGB yield curve