South Africa’s benchmark (ten year) government bond (govi) has averaged lower this year (8.46% to date) than last (8.85%), while the equivalent US and German gilts have seen lower averages last year (2017 bund 0.38%, US treasury 2.33%) than this year (2018 to date bund 0.59%, US treasury 2.80%). Indeed, SA’s ten year gilt (govi) reached a low of 8.08% on the market Ramaphoria that ran through to March, rising this month though to 8.66% on market fears of higher US rates.
SA has seen the rand weaken to R12.72/USD last week as the US dollar strengthened to 1.18 to the euro, as euro zone economic data failed to pick up as expected. Reported record levels of short US dollar positions were unwound while higher US treasury yields and market rates widened the interest rate gap for the US, prompting outflows from EMs.
Indeed, some market participants now expect a delay in UK and euro zone rate hikes on the weaker growth data for these regions, while the yield on the key US treasury breached 3.0% again, and the oil price rose towards US$80/bbl (see “Rising oil prices and rand weakness spells higher petrol prices and inflation for SA, disincentivising for an interest rate cut at the next MPC meeting”, 9th May 2018, website address below).
Global risk off was marked last week, and the IIF reported that a net portfolio outflow from EM markets of –US3.2$bn occurred, mainly from debt markets as South Africa saw the largest outflow. Indeed, –R15.0bn in foreigners’ sales net of purchases of South Africa’s gilts occurred, and net foreign sales of –R4.1bn of SA equities, a net outflow of R19.1bn in one week, the second largest outflow recorded historically.
The week of 24th October 2008 recorded the largest outflow for SA, a historic –R20.9bn in foreign gilt sales net of purchases and net foreign sales of –R4.2bn equities in SA, the peak net outflow for one week (of R25.1bn) which occurred in the 2008/2009 financial crisis. However, absent a global financial crisis, last week saw an extremely large portfolio outflow from SA, indicating the risks for the rand.
This week so far the domestic currency strengthened to R12.18/USD, with the USD reaching 1.20 to the euro, as markets regrouped, with the R186 at 8.32%, after reaching 8.49% last week. Nevertheless, the threat of a faster trajectory of US interest rate hikes than previously factored in, and the resultant significant recalibration of markets, indicates the very real risk SA continues to face to the downside from global events.
With portfolio inflows on South Africa’s capital account financing the deficit on its current account, the rand, and South Africa, remains very vulnerable to substantial global market swings. Currency weakness also feeds through fairly soon into higher inflation for South Africa, with the trade weighted rand now 2.8% weaker than at the last MPC meeting.
The FRA curve currently has a relatively flat outlook for this year and next, with only a mild possibility of a 25bp cut in the repo rate at the end of this year. The rand’s weakness to date since the last MPC meeting, and the rise in risk aversion in global markets, will likely dissuade the MPC from a May interest rate cut. Indeed, a rate cut so soon after the March MPC meeting would signal a more aggressive interest rate cut cycle that the SARB likely would be comfortable with.
Higher commodity prices are expected to place significant upwards pressure on US inflation from 2019, if not before, and negatively impact investor sentiment and EM currencies. Consequently, the risk for additional rand weakness this year in further anticipation of these events is clear. We still expect that US bond yields will likely rise more permanently above 3.0% from as early as the second half of this year into 2019.
However, in the shorter-term, interest rate differentials between emerging markets and developed countries are still relatively attractive, and so EM currencies could see some periods of renewed strength this year, including the rand, as the carry trade falls back into favour for a while. EM volatility remains likely, particularly for the rand.
The opinions and views expressed are for information purposes only and are subject to change without notice. They should not be viewed as independent research, recommendations or investment advice of any nature.