Quarterly Commentary - Q2 2020

Market comment

Global financial markets staged an impressive recovery in the second quarter of 2020. Financial markets have held up extremely well given the unprecedented nature of the economic shock experienced globally. While strict lockdowns have been relaxed in many countries, the recovery in financial markets is more attributable to the extent of the stimulus provided by central banks and governments, and not necessarily because of a rapid improvement in the underlying economies. The International Monetary Fund confirmed this view in its recent publications and indicated that this phenomenon may increase the possibility of financial conditions tightening at some point in the future.

Increased risk appetite from investors and the liquidity available found its way into emerging market assets, which boosted asset prices post the sell-off in March. South African equity and fixed income markets were included in this basket. The domestic bond market was buoyed by a lower repo rate, lower inflation forecasts, the second phase of government’s policy response, and foreign investors selling local bonds at a much slower rate, despite the country exiting global indices such as the World Government Bond Index. The South African Reserve Bank (SARB) continued purchasing domestic bonds in the secondary market, in a sustained effort to support the market and prevent any further dislocations. However, it must be noted that the SARB has repeatedly emphasised that this is not a quantitative easing programme.

The SARB’s Monetary Policy Committee (MPC) cut the repo rate by 150 basis points over the course of two meetings held in the quarter. The first, an emergency 100 basis point cut, was implemented in April post the extension of the lockdown, due to a large downward revision to growth forecasts. The second followed at the MPC’s May meeting, at which it revised growth even lower and forecast that inflation would drop below 3% for the next six months (before normalising next year). These aggressive cuts were made mainly to relieve the struggling consumer. While further cuts are expected, they will likely be smaller. At quarter end, the forward rate agreement market was pricing in further cuts of close to 50 basis points for this year.

Portfolio activity and positioning

The money market curve continued to follow the repo rate lower, with money market rates falling by almost 200 basis points as at quarter end. Throughout the quarter we continued to take advantage of a steep money market curve by investing into one-year bank paper, albeit at rates that were lower than in the previous quarter. This is still beneficial to the money market portfolio, as call deposit rates are very low and are likely to trend lower with further repo rate cuts.

We believe that there is a high probability that the SARB will cut the repo rate in the coming months. Growth in the local economy is likely to be the worst recorded in our democratic history. In addition, inflation should remain tempered, as demand is weak and inflation pass-through from the depreciation in the rand remains low. As mentioned in previous commentaries, it is important to bear in mind that South Africa’s saving shortage requires high real policy rates to attract investors. This alone puts a limit on the extent of interest rate cuts and on how long low real interest rates can be maintained.

We continue to invest into longer-term money market bank paper as opportunities present themselves. Overall, the portfolio will maintain a high level of liquidity through call deposits and bank paper. Local banks are still well capitalised and supported by the SARB, which puts them in a good position to weather this storm. The fund’s income will be lower than in the previous quarter, as reinvestments and inflows are invested into lower-yielding instruments. However, it is still likely to remain above inflation in the short to medium term.


Written by Vaneshen Naidoo

Portfolio Manager

Vaneshen joined Granate Asset Management in December 2015 and currently manages the Money Market and Cash portfolios in the Fixed Interest Team. He joined Cadiz Asset Management in 2006 as a graduate and during this time analysed the credit and property sectors for the fixed interest and multi asset class teams. Vaneshen holds a BSc. Hons (Engineering) and M.Sc.(Engineering) from The University of Cape Town, and is also a CFA.

M.Sc. (Engineering) (UCT)
BSc. Hons (Engineering) (UCT)