February was a volatile month for markets. Concerns that hawkish central banks could dampen prospective growth in their efforts to curtail inflationary pressures, dominated in the first half of the month, but was rapidly replaced when Russia invaded Ukraine. While risk assets suffered under the uncertainty of geopolitics, commodities rose to reflect the potential supply disruption and future scarcity.
Global equity markets declined across the board, with European bourses most impacted. The DAX lost 6,3%, bringing the year-to-date decline to 10,1%. The S&P 500 lost 3,0% in February, even with the backdrop of credible quarterly earnings results from US corporates. The technology heavy Nasdaq 100, bore the brunt of the negative momentum from frontloaded interest rate expectations, losing 4,5%. Emerging markets also lost ground, with the MSCI Emerging Markets Index declining 3,0%, with commodity producing countries offering some ballast against the risk off environment. Exposure to energy and mining helped UK markets, with the FTSE 100 holding up at 0,3%. The MSCI World Index declined 2,5%, bringing returns over the last twelve months to 11,2%.
Commodity prices rose on geopolitical tensions, with energy markets becoming both the epicentre of inflationary risk and a geopolitical pinch point. At their February meeting, OPEC+ members opted to stick with the gradual increase in production, rather than ramping up production in the face of increased demand and higher oil prices. While some countries have released strategic oil reserves since the intensification of the Russia-Ukraine conflict, this has done little to stymie price momentum. The price of Brent crude oil ended the month at circa $100, a 30% increase from the start of the year, while European natural gas prices rose on average 15% over the month.
The Bank of England increased rates by 25bps in a vote of 5:4, with the four votes supporting a 50bps increase. The ECB kept rates unchanged but expressed far greater caution than in the past, acknowledging an inflation print in January of 5,1%, which exceeded expectations. In the US, inflation also edged higher, heightening expectation of even tighter monetary policy. Global bond markets traded under pressure, as bond yields rose to reflect more hawkish sentiment, only to fall back on dampened growth expectations as geopolitical tensions intensified. The US 10-year bond yield exceeded the 2,0% level for the first time since 2019 by mid-month but ended to month at 1.8%. Markets are now placing a higher probability on a recession in a few years from now. In US dollar terms, the Barclays Global Aggregate Index declined by 1,2% in February.
While the situation in Russia and the Ukraine remains fluid, the immediate pressure points for the global economy were quickly revealed. Russia represents a small part of global equity markets and on average makes a modest contribution to global economic growth, although many global companies have operational exposure to Russia and Ukraine where the impact of current events could be felt. The broader and more significant impact, however, is via supply chains, global trade, commodities, and the impact of sanctions. The clearest transmission is currently via the energy market and related prices. Russia is a major commodity producer and contributes more than 10% of global crude oil and more than 15% to global natural gas production. Other significant commodities affected by this conflict include wheat and palladium, which could impact the auto industry and food prices. A significant component of Europe’s energy imports come from Russia, and their well-documented reliance on Russia’s supply of natural gas poses a region-specific inflation and growth risk.
Policy makers face a challenging backdrop, with soaring energy prices adding to inflationary pressures, while that same trend, alongside increased interest rates could well lead to lower activity and economic growth. The risk of policy mistakes or misjudgement has risen, and the markets are taking note.
STRIKING A CRITICAL BALANCE
The State of the Nation (SONA) reemphasised reform priorities, notably in network industries, with a focus on the role of the private sector, as well as an improvement to business operating conditions, to be furthered by a newly formed red tape task team. The President also announced the extension of the Social Relief of Distress grant of R350 for another 12 months. This was largely anticipated and formalised in the 2022 Budget, presented later in the month by Finance Minister Enoch Godongwana. The 2022 Budget struck a balance between social support and tax relief, while still addressing a sizeable debt burden. The fiscal metrics came in broadly in line with markets expectations, with an improved starting point and trajectory due to an estimated overrun of revenues of R182bn. The greatest uncertainty remains on the expenditure side, including the outcome of further public sector wage negotiations, SOE financial support and the shape of future social support measures. Nonetheless, the Budget was well received. The Constitutional Court ruled in favour of government regarding the non-payment of the 2020 public sector wage increases, removing uncertainty with regards to the additional expenditure. Energy regulator, NERSA, awarded Eskom tariff increases of 9.6% for 2022/23, much lower than the request of 20.5%. While this is good for consumers, it will be a consideration for Eskom’s finances. Despite a volatile backdrop for emerging markets, the Rand held ground, modestly appreciating by 0,2% against the US dollar. The All Bond Index gained 0,5% in February, with improved sentiment from the Budget, no changes in auction levels and the Constitutional Court ruling, largely overshadowed by international geopolitics.
Local equity markets benefitted from rising commodity prices with the FTSE/JSE All Share Index gaining 2,9%. Bellwethers Naspers (-21,7%) and Prosus (-26,0%) lost significant ground as further Chinese regulations on food delivery services, broader pressure on global technology stocks and modest exposure to Russia weighed on the counters. This led to higher returns for the FTSE/JSE Capped SWIX 40 at 4,1%. The resources sector gained 16,1% with PGM counters benefitting from a surge in palladium prices. The property sector declined 3,3%, accounting for broader exposure to the CEE region.