Rate hikes: when not if

FX

The SARB left the repo rate unchanged following its March 2014 MPC meeting, which concluded Thursday. The outcome was in line with majority opinion surveyed in the Bloomberg consensus poll. Seventeen out of 22 analysts had expected that the Bank would remain on hold. Three had expected that the Bank would hike by 25 bps, and two had expected it would hike by 50 bps. Within the Committee itself, the decision was once again split. Four were in favour of staying on hold; three argued for a hike. Among those arguing for a hike, views were split between 25 bps and 50 bps. This means that the number of members arguing for a 50 bps hike should not have been more than two. This compares with five in favour of the January hike and two in favour of no move. We believe it would be reasonable to assume that the same two members arguing against a hike in January were not in favour of a hike in March. Hikes of between 25 bps and 50 bps were discussed in January. A split ‘vote’ within the MPC adds uncertainty as to the timing of further monetary tightening, and regarding the increments involved. It means that only one member needs to flick back to the hiking camp for further tightening to occur. And it need not take a further big inflation scare to provoke the next tightening step, given that the choices need not sit as far apart as zero versus 50 bps, and especially once inflation breaches the 6.0% ceiling (by Q2:14, according to the SARB’s and our estimation).

The SARB’s rhetoric remained hawkish. While the inflation forecast for 2015 was revised downwards, this was mainly because it took into account the lagged impact of the January rate hike, which the January Statement did not. The Bank described the improvement to its medium-term inflation forecast as “marginal”. The Governor was also crystal clear that the path for monetary policy settings was upwards. She said in the informal Q&A that this is “certainly” an “interest rate raising cycle”. The word “cycle” is significant here. The Statement reiterated that “though we are in a tightening cycle, there will not necessarily be a change in the stance at every meeting, and that the increments may not always be of the same magnitude”. This implies that the debate applies only to when and at what pace the MPC will tighten, rather than if they will tighten.

The Bank is likely holding onto the hope that much of any tightening it views as inevitable will be done in a countercyclical rather than pro-cyclical manner – that is, into accelerating rather than decelerating domestic demand. Pro-cyclical hikes are not ‘normal’ policy adjustments. Countercyclical monetary policy adjustments are ‘normal’ adjustments, and the mean to which the SARB would be inclined to revert. While it would be prepared to hike if the inflation outlook were to deteriorate once more, it would prefer to hike only when the domestic growth outlook improves (and, more likely, only once domestic growth accelerates and recovery is assured). And growth is not about to accelerate. This means that the Bank’s preference will remain to postpone/back-load rate hikes. “The real policy rate is currently below what can be considered normal in the long run and is likely to increase over the medium term”, the Statement read. These comments speak to a mean reversion principle. But the reason the policy rate is away from its mean is because circumstances are not normal, and normalisation in this context would be growth normalisation, and growth normalisation would – in turn – be growth acceleration. “South African interest rates would also need to normalise”, the Governor said. But she then pondered: “The challenge, of course, is what is normal?”

The Bank is conscious that “[t]he expected normalisation of monetary policy in advanced economies is unlikely to be linear or smooth, and the timing and pace is uncertain.” However, markets will adjust on changes in signals of policy intent from the world’s big central banks, and much of this will likely be done well in advance of actual policy adjustments. We think that tightening might thus be more front-loaded than the SARB would prefer, and that the trigger for this tightening will be further bouts of depreciation in the exchange rate. A comparatively wide and sticky current account deficit and comparatively low real short-term interest rates mean that the rand, while cheap, remains vulnerable in risk-reward terms relative to other EMs. We still believe that the interaction between the currency market and monetary policy could play out like a game of ‘cat and mouse’. The timing and pace of hikes will to a significant extent depend on the timing, degree and pace of currency market adjustments. We expect that this game could continue until a further 100 bps’ worth of hikes is in place. We have up till now called for this to occur by the July meeting. Given no hike at the March meeting, persistence of the risk on mood in global financial markets, and the Bank’s repeated references to the possibility of pauses and different sized increments, the risk to our central case for another 100 bps’ worth of hikes is that this tightening could take a bit longer.

National Treasury will publish its Statement of Revenue and Expenditure for February today. Preliminary financing figures published earlier this month point to a fiscal surplus of around ZAR12.3 billion. This would compare favourably with a surplus of ZAR9.6 billion in February last year, and would suggest that the Budget deficit for FY13/14 is on track. This would be positive from a creditworthiness perspective and would thus be rand friendly. The consensus forecast sits at ZAR9.5 billion.

Yesterday’s release of Eurozone money and credit data confirmed that private sector lending remains a weak spot. M3 money supply grew by 1.3% y/y in February – a slightly faster pace than January’s 1.2% score. However, the contraction of lending to the private sector (adjusted for sales and securitisations) deepened to a record -2.0% y/y. Eurozone credit data remains indicative not only of weak demand for loans, but also of restricted supply, which is in part due to a heightened regulatory burden. Weak conditions in the region’s credit market, together with the threat of deflation and waning economic momentum, keeps the prospect of further ECB easing in play. Across the channel though, strong retail sales numbers published yesterday affirm that the UK is most likely much further along the recovery path than the Eurozone. Retail sales (including autos) climbed 3.7% y/y in February, much better than the anticipated 2.4% increase (Bloomberg consensus). With the US and the UK deeper into an economic expansion, it implies that their central banks are closer to tightening. Contrasted against the ECB, which will it seems need to engage in further easing, we should over the medium term see some euro weakness against the likes of the dollar and sterling. Over a 12-month horizon, Steve Barrow (our G10 Strategist) sees the euro reaching 1.30 and 0.78 against the dollar and sterling, respectively. Over the near term, though, the ECB’s hesitation towards any active change to its monetary policy should stave off any sustained euro weakness for now.

Today sees the release of US PCE inflation data for February. PCE inflation is the Fed’s preferred measure of inflation from a policy calibration point of view. Analysts expect that the headline number will sink to 0.9% y/y in February (Bloomberg consensus) from 1.2% in January. The Fed’s long-run goal here is 2.0%. The FOMC expects “inflation to move gradually back towards this objective”. However, the Committee remains vigilant to the “risks to economic performance” posed by “inflation persistently below its 2 per cent objective” and is “monitoring inflation developments carefully”. With the unemployment rate now only just above the 6.5% guidance, it would likely take a considerable deterioration in labour market data to alter the FOMC’s outlook of sustained labour market improvement (nonfarm payrolls data will be published next week Friday). It would then appear that the greater risk with respect to data surprises that could potentially alter the Fed’s path of policy normalisation sits in inflation indicators/drivers. We could see market participants becoming more sensitive to inflation data in the period ahead.

The rand strengthened significantly against the dollar for the fourth consecutive day yesterday, closing at USDZAR10.58 compared with Wednesday’s close of USDZAR10.71. This occurred into a mixed performance from the dollar against the major crosses, and into broad based-strength in commodity and EM currencies. The dollar strengthened against the euro and the yen, while weakening against the pound. The rand strengthened against all of the major crosses, with the biggest move seen against the euro (-1.5%). All of the commodity currencies we monitor for purposes of this report strengthened on the day. All but three of the EM currencies we track strengthened on the day; the exceptions were the INR, the RUB and the IDR. The rand was the best-performing commodity currency and the second-best-performing currency in the EM currencies category (beaten only by the BRL). The rand traded between a low of USDZAR10.5650 and a high of USDZAR10.7332.

The rand strengthened after the MPC announcement. We had indicated that the impact of the decision on the local currency market would depend on whether it occurred into risk on or risk off, and it occurred into risk on. It is possible that the causality between the rand and EM currencies in general was running in both directions (both were helping each other). It is possible also that the certainty the Bank appeared to offer regarding a monetary tightening cycle, as well as the fine balance between those in favour of hiking versus not, helped to anchor the currency. Support from where the rand opened this morning sits at 10.5800, 10.5000, 10.4550 and 10.3700. Resistance levels sit at 10.6800, 10.7300, 10.7700 and 10.8150.

Turning to commodity prices, copper and Brent both rose by 0.8%. Gold and platinum meanwhile fell by 1.0% and 0.4%, respectively. The ALSI fell by 0.6%, while the EM MSCI by 0.7%. The EMBI spread compressed by 6 bps, while the SA’s five-year CDS spread widened by 0.4 of a bp. The CBOE VIX index, a volatility proxy for global risk appetite/aversion, fell by 2.1%.

Non-residents were net buyers of local equities (ZAR251 million) and were meaningful net buyers of local bonds (ZAR976 million) on the day. Buying of bonds appears from pricing action to have been a response to the MPC decision and clarity in its rhetoric around a tightening “cycle”. Buying of bonds was seen in 12+ (ZAR940 million) and 1-3 (ZAR767 million) year segments. Selling of bonds was meanwhile seen in the 3-7 (-ZAR462 million) and 7-12 (-ZAR269 million) year buckets. Bond yields fell by between 6 bps (R203) and 11 bps (R214) into a bull curve flattening. The 3x6, the 6x9 and the 12x15 FRAs fell by 15 bps, 19 bps and 11 bps, respectively, also on yesterday’s outcome and official ‘guidance’.

In local labour news, Joseph Mathunjwa (AMCU president) said yesterday that "[t]he Chamber of Mines is a mouthpiece for the oppressor." He also went on to say, "[w]e have filed an application with Nedlac in Rosebank … We want our workers in the gold and coal sectors to join us." Charmane Russell (Chamber of Mines’ spokesperson) has indicated that gold producers would vigorously oppose any move to commence such a strike. Marches would extend to Lonmin next week, and to Parliament after the Easter holidays, if wage demands were not met, Mathunjwa has indicated. The strike is now in its tenth week; and no resolution appears to be in sight.

FI

At today’s ILB auction, NT is planning to raise ZAR800m in the I2025, I2038 and I2050. Last Friday’s auction saw lower demand for the (same three) bonds on auction by way of total bids received at the offering (ZAR1.50bn), compared with an average of ZAR2.22bn recorded over the previous five ILB auctions. However, real yields have continued to decline through this time. With the SARB’s unchanged view on the inflation profile for this year, we could continue to see decent demand at these auctions.

Local government bond yields fell by between 4.50 bps and 11.50 bps in a bull flattening of the curve yesterday, with the largest moves stronger seen at the longer-end of the curve. While yields were trending lower through the day, more pronounced declines were recorded following the MPC meeting, in which the SARB keep the repo rate on hold at 5.50%.

The yields on the R213 and the R2048 fell by the largest increment, 11.50 bps each, to 8.69% and 8.955% respectively, while the R2037 and R214 fell by 11.00 bps each. The remaining bonds in the extended maturity segment saw their yields fall by 10.50 bps, with the exception of the R186, which recorded a 7.50 bps decline, to 8.33%. The R157 recorded a 5.00 bps decline in its yield. The spread on the R186/R157 compressed by 2.50 bps yesterday, to 154.00 bps, and the R213/R186 and R2048/R186 spreads compressed by 4.00 bps each to 36.00 bps and 65.50 bps respectively. SA’s CDS spread improved on the day, to 191.00 bps, from 194.84 bps on Wednesday.

The 10-year UST yield fell sharply yesterday, to an intraday strong point of around 2.66%; the yield is currently trading north of 2.68%, which is still lower compared with Wednesday’s closing level of 2.69%. While the 5-year UST yield followed a similar trend (to the 10-year UST yield), the note ended the day on a weak point, at a yield of 1.72%, from Wednesday’s 1.67%.

Local bond market turnover was recorded at ZAR23.37bn yesterday; ZAR23.60bn of this was due to nominal SAGBs, while a paltry ZAR107m of turnover was recorded in government ILBs. Non-residents purchased +ZAR976m of nominal SAGBs yesterday. Foreign buying was recorded at the tail ends of the curve, in the 1-3 year (+ZAR767m) and 12+ year (+ZAR940m) maturity categories, while net selling was seen in the mid-tenor, 3-7 year (-ZAR462m) and 7-12 year (-ZAR269m) buckets. There was particular interest in the short-dated R157, which recorded net inflows of +ZAR821m. The R157, was one of the only SAGBs that had weakened into yesterday’s MPC meeting (with a large reversal on the back of the interest rate decision). In the 12+ year segment, +ZAR597m was purchased in the R186 and +ZAR371m was purchased in the R214, while notable foreign purchases was also recorded in the R209 (+ZAR155m) and the R2030 (+ZAR100m). Foreigners sold –ZAR271m in the R186. In the 3-7 year maturity bucket, foreigners sold -ZAR412m in the R203 on the day.

In a positive move in the EM space, ratings agency S&P, revised Hungary’s outlook to stable from negative. The agency rates Hungary two notches below investment grade, at BB on a foreign currency scale. The revision was on the back of a more favourable outlook for GDP growth, which the agency expects to reach 2.00% in the 2014/15 financial year. In its statement, S&P noted that “the Hungarian domestic economy is stabilizing after half a decade of external deleveraging”. The agency also positively highlighted that the country’s “steady export performance amid a multi-year credit crunch, alongside absorption of EU funds, have shifted the current and capital accounts into surplus, reducing external vulnerabilities”. Both Moody’s and Fitch rate Hungary’s foreign currency debt one notch higher at Ba1 and BB+ respectively.

In the EM FI space, 5-year EM bond yields declined by 3.41 bps on average yesterday, while 10-year yields declined by 4.45 bps. Brazil recorded the best performance out of the EMs we cover for the purposes of our reports; the 5-year yield fell by 21.40 bps, and its 10-year yield, by 21.80 bps. Turkey’s yields also fell notably compared with the EM average, with its 5 year yield declining by 12.00 bps, and its 10 year yield, by 17.00 bps. Indonesia’s 10-year yield declined by 10.80 bps while the 5-year yield fell by a smaller increment, of 2.20 bps. SA’s 5 year and 10 year yields fell by 5.20 bps and 7.00 bps respectively. Russia’s FI market recorded the worst performance on the day, with its 5-year and 10-year yields rising by 13.50 bps and 12.63 bps respectively.

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