Dear Investors

The appetite of investors into emerging markets was tested once again this month.  To begin the month, the pound fell to its weakest level in three decades against the dollar, surpassing previous lows reached in the aftermath of Britain’s vote to leave the European Union.  Sterling touched $1.29 and sank to its lowest since 2013 against the euro as evidence piled up that Brexit is hurting confidence in the U.K. economy and resulting in a contraction in credit. In an attempt to stem the tide of investors exiting the UK and reduce volatility, the appointment of a new PM was accelerated and Theresa May was elected at new PM.  The response was relative market stability and improved appetite for risk assets.  Although sentiment over Brexit was still the main driver, we note that investor attention has begun to return to the ‘data’.

Global government bond yields also fell to fresh depths with Japan’s 20-year yield dropping below zero for the first time to reach minus 0.005 percent, while the 10-year U.S. Treasury reached (another) record low yield of 1.3397 percent. Expectations around US Fed hikes seems to have completely u-turned with some even pricing in the potential for rate cuts. The market expects the Fed to maintain rates on hold for the rest of this year which bodes well for African market currencies. The prospect of stimulus measures in Asia following Abe’s decisive victory and further stimulus from the ECB is helping ease concerns about Brexit and triggering a global search for yield.

While much of the rush into bonds has been pinned on Brexit jitters, we are looking at the longer term trend of central bank intervention that appears to have herded investors into sovereign debt.  Record low bond yields have also boosted demand for safe haven assets such as gold, with gold ETF holding over 2000 tons of the metal, however regardless of the reason, we believe that global bond yields have returned to levels where investors don’t make any money.  And as one of the outcomes, the ‘carry trade’ should again return to emerging markets.

A great thought, but before the ink on the idea had time to dry, the failed coup turkey and President Erdogan's crackdown made emerging market investors nervous about what is next for the country.  Banks and credit rating agencies all reacted strongly advising clients to exit the region.  The outcome has been a steady inflow into South African local risk assets as the country became one of the few EM regions to show stability.  In addition, South Africa recorded a second consecutive monthly trade surplus in June as exports of vegetable rose (as rainfall returned to much of the cape), while oil imports also rose – an early growth signal. These latest trends will support the rand and reduce the chances of another interest rate hike.  Although our base case remains that South Africa is at the top of the interest rate hiking cycle, the local government elections set for 3 August, will provide additional direction on investor interest into the country.  The official opposition appears (as per the lasted poll) to be ahead in the three large metropolitan areas – Johannesburg; Pretoria and Port Elizabeth -  If even one of these fall to the DA it would signal a distinct change in how South Africans are holding their government accountable for growth and development.  As the base case for investors is a return to ANC control in all metros except the western cape.  We believe that a surprise DA victory in these elections will send a strong signal to investors about the strength of the SA democracy and bolster the currency and appetite for local risk assets.

On the Africa front, Nigeria’s central bank rate by a surprise 200 basis points to 14 percent  and maintained its existing cash reserve ratios for commercial banks in an attempt to stabilise the naira.  Stability in the Naira is key to us making investments into this country, we continue to observe developments and look for an opportunistic entry point.

Looking forward to our next communication

 

Derek Seely