Market Solutions – December: “Goldilocks conditions” remain in early 2018.

By Alexander Forbes Investments on Jan 19, 2018 in General

2018 has dawned with what some analysts are calling “Goldilocks conditions”: strong global growth, relatively low inflation, but still easy monetary conditions provided by the major central banks. As a result, risk assets such as equities and emerging market (EM) assets continue to perform well.
The extent of rand strength vs. the USD has surprised many, which is one of the risks we’ve radar. In our September 2017 issue, “The rand: a South African investor’s eternal conundrum” we noted: “A singleminded focus on the ANC’s elective conference could lead to a blind spot and clients could be surprised by the resilience of the rand as a result.”

After a disappointing Medium-Term Budget Policy Statement (MTBPS) the rand weakened to 14.20 vs. the USD. But it subsequently strengthened to below 12.20 – the strongest levels seen since mid2015, before “state capture” became a part of the political lexicon. The rand is now approaching “fair value” according to a basic Purchasing Price Parity (PPP) valuation measure. Currencies rarely remain at fair value for long and are known to over/undershoot valuation levels. Given the extent of USD weakness that has emerged globally, a continuation of the current rand strength can’t be ruled out.


Despite the inflation fears that emerged in Q4 2017, rand strength implies that the interest rate cuts we analysed in our October 2017 issue remain probable in 2018. Internal inflation analysis suggests that CPI inflation could still drop dramatically lower than current levels. Weak domestic economic conditions are contributing to the interest rate bias. Real GDP expanded by a meagre 0.8% in 2017. Economic growth should improve in 2018, aided by improved global conditions and a modicum of political stability. That being said, local structural economic constraints and policy own-goals won’t suddenly dissipate. The level of economic growth is unlikely to satisfy the vast majority of South Africans.

Interest rate cuts from the South African Reserve Bank (SARB) could see further capital flow into the South African bond market and cause bonds to strengthen, despite the difficult fiscal environment faced by National Treasury. Political pressure has been exerted on the fiscal authorities to find further funding to meet spending demands in February, which is when the Treasury announces the national budget. The reaction from the Treasury in February will be telling. While the budget is of obvious importance for South Africa’s economic trajectory, financial markets could still place more importance on global conditions than just the politicians in Pretoria. If global conditions remain favourable, South Africa, along with its EM peers, could be viewed favourably. Whereas when risk appetite deteriorates globally, EMs are disciplined.

2017 saw the strongest inflows into EMs in a number years, highlighting the favourable global conditions for South Africa and rand assets over the past 12 months. Given the current strength in global economic growth, with PMIs signalling expansion across the major economies, one should expect a continuation of this positive EM momentum in early 2018. Global investors could interpret the South African budget through a positive lens as a result. However, a deterioration in global economic conditions would certainly put a cat amongst the pigeons later in 2018, particularly if South African assets such as the ZAR, equities and bonds are overvalued at that stage.

Alexander Forbes Investments

Alexander Forbes Investments

Alexander Forbes Investments was established in 1997. We are a forward-thinking and trusted global investment provider, with roots in Africa. In pursuit of certainty we set out to understand our retail and institutional clients’ circumstances and risk tolerance to set clear goals. Our adaptive investment approach, called Living*Investing allows us to maximise opportunity and minimise risk at every stage of the investment cycle.

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