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Local investing

Money Market Fund update: Rising inflation and low growth continue to cause concern

Global yields have fallen after Brexit became a reality when the UK voted to leave the EU. This uncertainty has decreased the expectation that the US Federal Reserve (the Fed) will raise interest rates in the foreseeable future, with emerging market bonds being a beneficiary of this potential outcome as global investors hunt for yield.

SA avoids credits downgrade, for now

South Africa managed to avoid a downgrade of its sovereign rating from all three of the rating agencies, however this risk is not off the table just yet; it has only been pushed out until December as the credit default swap (CDS) market is still pricing South Africa as a BB+ rated sovereign. The 12-month JIBAR rate traded over a 20-basis point range during the quarter, reaching a high of over 8.80% in late May, as interest rate expectations were adjusted leading up to the ratings announcements. It is currently back at the 8.58% level where it started the quarter.

At the last meeting of the Monetary Policy Committee (MPC) of the South African Reserve Bank (SARB), the repo rate was left unchanged at 7% per year, with five of the six members voting for no change in the rate. However, the statement remained hawkish, citing concerns that inflation may rise due to the exchange rate pass-through that has still not materialised and the impact of the drought. Nevertheless, the Consumer Price Index (CPI) inflation reading for May came in below expectations at 6.1% year-on-year, just outside the SARB’s inflation targeting band of 3% to 6% year-on-year. The positive surprise was the lower-than-expected food prices driven by vegetables, fruit and meat. The average CPI inflation for the year is still forecasted to be above the 6% threshold, which will likely see the MPC raise rates again towards the end of the year as it follows its inflation-targeting mandate.

The constant dilemma that the MPC is facing with rising inflation and low growth was intensified when the latest GDP print came in much worse than expected at -1.2% quarter-on-quarter (annualised) and -0.2% year-on-year. These very low growth numbers are making it harder for the MPC to ignore growth when making its interest rate decisions to combat inflation.

Our strategy remains unchanged

Our strategy in the Allan Gray Money Market Fund remains unchanged. We still believe that the money market yield curve is steep, which provides value in the longer end of the curve where we have been able to take advantage of any spikes in the one-year area arising from the volatility in the interest rate market. We also see value in shorter-dated treasury bills for liquidity purposes, as they currently offer a yield pickup over banks, and we continue to invest in floating rate notes which will benefit from any future interest rate increases.

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