Tertia Jacobs

Tertia Jacobs

Treasury Economist

Fed and SA

The hawkish surprise in the Fed’s SEP forecast of the dot plot and “talking about tapering” has raised perception of an inflection point for US monetary policy. This holds implications for the direction of the USD, the slope of the US yield curve and global capital flows into emerging markets. The context of the June FOMC meeting was a meaningful acceleration in GDP growth (SEP 2021F: 7.0% vs 6.5%; 2022 unchanged at 2.2%; and 2023 2.4% vs 2.2%), as well as inflation (2021 PCE inflation: 3.4% vs 2.4%; 2022F 2.1% vs 2.0%; and 2023 at 2.2% vs 2.1%), driven by base effects as well as the opening of the economy. Where the Fed was previously adamant that the increase in inflation would be transitory, the communication at the June meeting reflects a higher level of uncertainty. The hawkish surprise came in revising the dot plot interest rate forecast.  The median dot forecast for 2023 incorporates two rate hikes compared to the March meeting, which reflected no interest rate increases. The June FOMC meeting shows the Fed’s awareness of the risk of a more permanent increase in inflation. The more hawkish view is likely to lead to a repricing of rate hike expectations, especially in the front-end of the US yield curve. This is an important driver of USD hedging costs and hence the direction of the USD.

South Africa market dynamics: For emerging markets such as South Africa, the withdrawal of liquidity from higher US interest rates is an essential driver of global capital flows and the rand. The catalyst for ZAR strength since late 2020 has been an acceleration in commodity prices which has led to an increase in the value of exports and healthy surpluses on the merchandise trade account. Recently, however, we have noted that the rally in the ZAR has been amplified by the carry trade, caused by the Fed’s communication from March around the inflation outlook and bond tapering, which has bolstered the ZAR to best-performing currency. The flattening of the SAGB yield curve reflected a reduction in the risk premium due to an improvement in the fiscal position and a reduction in the quantum of weekly bond supply and the carry trade – especially in the belly of the curve. The Fed’s statement caused the ZAR to weaken from R13.77/$ to R14.09/$ and the yield on the R2030 from 8.76$ to 8.96% (at the time of writing).  While the ZAR will continue to derive support from a surplus on the merchandise trade account in the coming months (although this is likely to fade towards year-end and 2022), the volatility risk arising from US inflation in Q3 and Q4 will shape the Fed’s risk assessment of inflation. While we expected the USD to be on a weaker foot in Q3 21 (with the DXY breached a strong resistance level, the Fed’s hawkish slant implies that the USD can continue to remain range-bound. Our view of the fair value on the SARB 10 year yield remains at 9.0% to 9.25% (and the R2030 at 8.9% to 9.15%). The FRA curve has steepened and 6 to 12 month money market rates have edged higher.