Macro Overview | Second Quarter 2023

Global growth has been slowing for the last few quarters. Contrary to our expectations of a sharper slowdown in the US and stronger recovery in China, economic data suggested that the US household consumption has remained resilient on the back of a strong and tight labour market and still large amounts of excess savings available to spend. China data on the other hand has been disappointing suggesting the business and consumer confidence remains very weak despite the full re-opening of the economy.

We continue to expect a mild recession in the US over coming quarters. The buffers that protected consumption are fading and we see early signs of labour market weakness. The full impact of earlier rate hikes has not been felt yet. The more cyclical manufacturing side of the economy has been in recession the last few quarters as spending patterns has shifted from goods to services. Inventory levels of manufactured goods are high, and destocking is required before manufacturing will rebound. This trend can be seen globally, not just in the US and is largely also responsible for weak China manufacturing and trade data. China’s recovery has been tepid and risk a deflationary cycle unless policy makers respond more aggressively to shore up growth. We expect more China policy stimulus over coming months.

While interest rates are clearly in restrictive territory, inflation data has not softened sufficiently. Central banks in Europe and UK are further behind the curve than the US and will need to do more tightening over coming months. We expect the US rates to peak potentially as soon as the July meeting. Scope for cuts remains limited. While we do see inflation softening from current levels, we doubt that core inflation will fall back to target anytime soon. Our longer-term outlook of structural high inflation implies that interest rates will also remain higher for longer. Emerging markets does not face the same inflation pressures as the developed world and are better placed to ease policy as headline inflation comes down faster. We expect economic growth in emerging markets to improve with further China stimulus, higher commodity prices and a weaker US dollar.

Our weaker US dollar view stems from peak Fed rates, softer growth in the US, improved growth outside US and still hawkish central banks in Europe. Portfolio outflows from the US combined with an increasing US trade and fiscal deficit will put further pressure on the US dollar over the long term. Although the US dollar will not lose its reserve currency status for many years or decades, the de-dollarisation themes has gained some momentum.

Geopolitically the fragmentation between the US and China has deepened. The risk of confrontation and increased decoupling between these nations weighs on Chinese assets. Russia’s war in Ukraine continues to pose upside risk to energy prices as does Iran’s gradual progress towards its nuclear ability.

South Africa’s economy is in a dark place. Risks around energy availability, western sanctions, high interest rates, high inflation, weak state-owned enterprises, fiscal slippage, and political instability abound. Valuations reflects a large degree of these weaknesses and appears attractive against other emerging markets. We are gradually turning more optimistic on the outlook. We acknowledge the risk for further downside but believe pockets of deep value may be present already. We are encouraged by the outlook for increased renewable energy supply and improved ESKOM energy availability factor over a 6 to 12 months horizon. With inflation falling, the scope for rate cuts over the next 6 to 12 months is rising.

Macro Review

Global equities rose 6.8% in dollars and 13.2% in rand over the last quarter. This rally was driven by a narrow set of consumer technology stocks and led by US stocks. Stocks aligned with progress on artificial intelligence has outperformed while the rest of the market was supported by lower inflation and decent economic data. Emerging markets underperformed and was largely flat over the quarter with China down almost -10% on growth and geopolitical concerns. Assets linked to China has underperformed including South Africa whose local equity market was up only 1.2% over the quarter. Resources underperformed largely due to PGM miners, but local banks and retailers had a positive quarter along with Naspers. During the quarter, the South Africa All Bond index dropped 1.5%, dragged down by concerns about
growth, potential sanctions, and fiscal slippage. Foreign investors sold local bonds. Cash returned 1.9%.

The Bloomberg Barclays Global Aggregate Bond Index dropped 1.5% over the quarter. US 10- year bond yields rose towards 4% as inflation remain sticky and data printed on the stronger side of expectations. The US yield curve remains deeply inverted, signaling tight financial conditions. US and European high yield credit spreads narrowed over the quarter.

Commodity prices fell over the quarter. On the industrial side, Iron Ore fell 10.2%, Brent Crude oil decreased by 5.6%, and Copper decreased by 7.6%. Gold dropped 2.5% as real rates rose and the US dollar strengthened. Platinum was down by 8.9% while Palladium decreased by 15.9%.

By Jacobus Lacock
Fairtree Fixed Income Portfolio Manager

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