The second quarter of the year offered investors a bumpy ride, as tariff threats and rising geopolitical tension played out in markets. Portfolio manager Sean Munsie discusses the quarter’s key developments and the local market’s revised inflation expectations.
President Trump’s “Liberation Day” tariff announcement on 2 April, followed by the subsequent threats, reversals and postponements, created a dizzying level of volatility in global financial markets during the second quarter. The S&P 500, as an example, is now back near all-time highs after falling more than 10% in early April. Indeed, at one point during the sell-off, US equities, bonds and the US dollar all weakened in tandem – a rare occurrence in recent financial market history.
The US dollar and US bond yields have not fared as well as equities, with both still weaker versus their initial levels. Trump’s One Big Beautiful Bill Act, which entrenches his first-term tax cuts together with new tax breaks and increased spending requirements, has added to investor uncertainty. The bill may increase federal debt by US$3tn by some estimates (roughly 7% of US GDP) over the next decade. In addition, any positive sentiment attached to the Department of Government Efficiency’s anticipated cost savings has quickly faded.
Trump’s haphazard approach to policymaking has also induced angst among global central bankers. Most have now adopted a more careful path to further monetary policy easing, given the two-sided risks that tariffs and heightened trade tensions may pose to inflation. Officials at the US Federal Reserve have dialled back their economic growth projections while simultaneously increasing inflation expectations – conditions more akin to stagflation. Ambiguity exists around whether the inflationary impact of tariffs will be a one-off step higher in prices or something more structural as firms manage the increase in input costs. Conversely, the continuing uncertainty may begin to weigh on consumer confidence and planned investment, further impacting prospects for growth. The expectation is for two cuts (or 50 basis points) in the US by year end.
The market eyes a lower inflation target
Locally, our Monetary Policy Committee has swung more dovish, lowering the repo rate to 7.25% at its May meeting, with all members voting in favour of the cut. This shift from its previous, more cautious approach may be attributed to several factors. The starting point is relevant given that the policy rate has been restrictive for some time, with the real rate at its highest level since the mid-2000s, a period during which inflation ran significantly higher. In the absence of an exogenous shock, such as a higher oil price, the current inflation outlook is benign, with the latest print at 2.8% – below the band targeted by the South African Reserve Bank (SARB). The trade surplus, helped by stronger gold and platinum prices, contributes to a stable exchange rate. And as local growth expectations are revised downwards, cost pressures stemming from increased demand are few and far between. Lastly, the passing of the Budget and the continuation of the government of national unity have eased fiscal concerns somewhat, evidenced by government bond yields at their lowest point for the year to date.
The SARB has also introduced the possibility of lowering the inflation objective to 3% versus the previous 3% to 6% band. While discussions between the SARB and National Treasury remain ongoing, the market has cheered the prospect of a new, lower target. Experience elsewhere suggests that once inflation settles down in the 1% to 3% range, it usually stays there. The current band is too high and wide relative to the low prevailing inflation that the SARB wishes to lock in. With administered prices still expected to outpace overall inflation, government support in the form of lower price-linked wage settlements is clearly required.