Markets rose in January as investors felt they had a good understanding of the inflation and interest rate dynamics to come. That view entailed ongoing disinflation with an imminent peaking in interest rates and expectation of some monetary policy easing in the latter part of the year. That January clarity of understanding was instantly replaced at the beginning of February with a view of sticky inflation coupled with the potential reality of higher interest rates that would be in place well into the year. Financial markets balked at this new notion and gave up a measure of their January index gains in February. No sooner had investors adopted this new vision of the market universe than something more bizarre came to light. It turned out that the recent rapid rise in interest rates, designed to reduce inflation back to target levels, had other ramifications. Some poorly managed mid-size banks in the US found themselves in trouble as depositors, anticipating a bank collapse, rushed for their cash. The Federal Reserve was forced to quickly intercede to protect depositors as Silicon Valley Bank became the second largest bank failure in US history with Signature Bank, collapsing soon after SVB, becoming the third largest.
Whilst equity markets adopted a risk-off environment in early March, US bond yields instantly changed tack. The two-year treasury yield fell over 100 basis points in three trading days in early March as investors shifted their expectations back to an environment of peaking interest rates and easing monetary policy. As March progressed, investors became a little more comfortable with the banking sector after visible support by the fiscal authorities became apparent.
Overall, the financial market performance in quarter one 2023 was broadly positive. Expectations are that the US Federal Reserve (“Fed”) rate hiking cycle is nearing an end which is supported by the reduction in US inflation from 7.1% in November 2022 to 6.0% in February and now at 5% In March.
South Africa suffered an inflation shock in March, with February’s CPI numbers (both Headline and Core) reverting upwards to 7.0% and 5.2%, respectively. Inflation expectations of the SARB were revised upwards with Headline Inflation expected to be 6.0% (up from 5.4% and Core Inflation at 5.9% (up from 5.5%). On the back of these sharp increases in inflation expectations, the SARB hiked Interest Rates by 0.5%. Although previously we felt this level would be the peak in the interest rate cycle, risks are firmly biased to the upside, and we may see further rate increases should Inflation pressures remain entrenched.
Economic growth, both globally and locally is forecast to remain sluggish, with global growth expected to be no more than 2.0% and locally an expectation of only 0.2%. We retain our outlook that the current market volatility and general market weakness is likely to persist throughout the first half of this year, with an increasing likelihood of recession. However, we remain constructive on our long-term inflation outlook in South Africa and believe that inflation will begin heading below 5% towards the end of this year.
Our Multi Asset Class risk-adjusted- return Models all performed acceptably within the first quarter and are in line with our expectations. No adjustments were made to any of the models within this quarter.
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