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28 Feb 2018

SA Gilts: Higher yields on rand weakness as March interest rate cut expectations fade, political and policy uncertainty seen to rise

Annabel Bishop

Chief Economist

  • After reaching a low of 7.90% this year (a low last seen in the first half of 2015) on rand strength following a perceived substantial reduction in political risk, the yield on the R186 has bounced back to 8.12%, with the rand now back above R11.80/USD (R11.84/USD, R14.45/EUR and R16.29/GBP). The FRAs (Forward Rate Agreements) do not factor in a March interest rate cut.
  • Specifically, South Africa is perceived to have seen a significant reduction in political risk since mid-December, culminating in a cabinet reshuffle shortly after Cyril Ramaphosa became president of South Africa, with Nhlanhla Nene and Pravin Gordhan (as Finance and Public Enterprises Ministers respectively) seen as the key appointments in the reshuffle. The domestic currency saw substantial appreciation, strengthening to R11.51/USD, R14.31/EUR and R16.08/GBP from R13.66/USD, R17.08/EUR and R19.09/GBP pre the ANC 2017 elective conference. 
  • However, the rand and SA bond yields backtracked this week, most notably against the US dollar on US dollar strength following perceived hawkish comments from new Fed Governor, Jerome Powell. Additionally, full erosion of private sector property rights (to land) without compensation became a likely future reality for SA this week as the motion in parliament of the EFF to change the constitution, was adopted by the ANC. 
  • The uncertainty as to whether expropriation without compensation will apply to all land, or only agricultural land, has increased policy uncertainty, amid a number of calls also for state custodianship of all types of private sector land. Until policy certainty is established, SA risks a slowdown in growth, to outright decline in property prices, lower agricultural planting and yields, and even reduced private sector capex and reduced hiring (particularly in the agricultural sector).   
  • SA’s expropriation bill submitted under the Zuma Presidency extended the proposal of expropriation without compensation of private sector property to all assets including buildings, financial assets (such as equities) and businesses. With the EFF gaining in popularity this week on its motion, the future political landscape of SA could see marked changes if growing expectations of expropriation without compensation continue escalating and are not met, particularly as many believe they will become the owners of the land, and not the state. Disappointment may be likely when many realise that the ownership of the land is still not theirs, while the state is set to increase its already large holdings of land in SA (through state custodianship). 
  • Substantially higher levels of business confidence, and so economic growth are expected this year and next, on the late 2017/early 2018 sharp reduction in political uncertainty as Cyril Ramaphosa became president (of the ANC and then of SA). However, these expectations would be unwound by a substantial rise in political and policy uncertainty.
  • The Budget has shown some fiscal consolidation, on expenditure and borrowing cuts and higher taxes, and does not necessarily argue for a Moody’s downgrade. However, on its own the fiscal consolidation in the Budget is not necessarily enough to fully counterbalance other key issues, such as significant financial concerns in SOEs and lack of a marked lift in GDP growth and incomes per capita, that concern the rating agencies. 
  • At best Moody’s may decide not to downgrade SA’s credit ratings to sub-investment grade by its cut-off date, 23rd March 2018, and instead review SA’s credit ratings again later this year or next to see if GDP growth has lifted and the SOEs financial concerns will be resolved. While this would provide rand and bond market relief, it is unlikely on its own to cause the rand to try to move through R11.50/USD towards R11.00/USD given the very recent market perceived rise in policy and political uncertainty.
  • This week foreigners sold R0.8bn in SA equities net of sales, with a net sell off of R1.4bn occurring yesterday. Higher US interest rates are expected by the market, resulting in USD strength, although longer-term the euro could strengthen further as higher interests for the euro zone are priced in by the markets on faster GDP growth expectations.