MPC meeting: maintaining credibility

FX

The SARB hiked the repo rate by 25 bps at the conclusion of its July 2014 MPC meeting yesterday. We had predicted this outcome, arguing that the SARB would take rates up by 25 bps premised largely on concerns the Bank might have regarding their perceived credibility and effectiveness at anchoring inflation expectations. We did admit that we viewed the risk of no change as material, given the persistent and even possible intensification of the Bank’s stagflation “dilemma”. The ambiguities in calling Thursday’s decision were apparent in the divergence among analysts’ opinions. According to the Bloomberg poll, 15 out of 30 analysts had expected that the Bank would remain on hold. The remaining fifteen were split between 8 anticipating a 50 bps hike and 7 predicting a 25 bps hike.

The Committee itself appeared quite decisive. During the Q&A session, Governor Marcus indicated that six favoured a hike, while only one argued for staying on hold. This is a marked turnaround from the May meeting, when five favoured staying on hold and only two ‘voted’ for a hike. Of those arguing for a hike at the July meeting, the Governor indicated that one had favoured a 50 bps increment. The Governor added that there had been a “reasonable discussion” considering the differences between 25 bps and 50 bps. In particular, she mentioned that the debate included what these alternatives imply regarding the likely impact and whether it is better to front-load or not – that is, whether smaller increments now might imply having to do more overall, or whether doing more now saves you from later work. She emphasised that despite the debate, there was “a very strong common understanding” of “the dilemma … we face”, the challenge though “is what the balance is” – the balance between rising/elevated inflation and stagnant/deteriorating economic growth.

Although the July Statement did not explicitly mention, as it did in May that “we are in a rising interest rate cycle”, during the Q&A session it was made clear that the Committee felt that this was the case and that they also felt that this was implied by the language of the July Statement. Specifically, Kuben Naidoo referred to the line in the Statement which reads, “The MPC has decided to continue on its gradual normalisation path …”. We think that the word gradual is also significant here. This speaks to a Bank stuck in a stagflation “dilemma” whose preference is to stand still, unless inflation risks are seen as sufficiently pronounced to endanger its credibility. The extent of any perceived threat to its inflation fighting credentials will determine the degree to which it will act – that is, the increment of any hike the Bank feels it is forced into. However, as long as the tug from stagnant/deteriorating growth remains so acute, we feel that the Bank will pause when the inflation outlook and inflation expectations allow; and that any hikes will be measured, to the extent that any deterioration in the inflation outlook or expectations allows. In essence, we feel that the following dictum from the May Statement still applies “a rising interest rate cycle does not mean that rates will be raised at each meeting, or by the same amount each time”.

Risk aversion climbed overnight as news broke that a passenger plane had been shot down over the Ukraine. This put the rand and other risky assets on the back foot. Treasuries, gold and other haven assets benefited from a flight to safety. The plane was apparently shot down over a region at the centre of the country’s ongoing civil conflict between pro-Russian rebels and the Ukrainian authorities. This incident has stoked geopolitical tensions, not only in the region, but also threatens to provoke an escalation in tensions – and possibly global political and economic consequences – between the Russia and the West. The news came amid an announcement of an escalation in Israel’s offensive in Gaza, adding to a general climate of geopolitical risk and uncertainty.

The rand weakened against the dollar yesterday, closing at USDZAR10.76, compared with Wednesday’s close of USDZAR10.68. This was on the back of an increase in geopolitical risk which occurred overnight, notwithstanding what is likely to have been viewed as a rand-positive move from the SARB yesterday. Local currency depreciation occurred alongside a mixed performance from the dollar against the major crosses. The rand depreciated into a weaker performance from all of the commodity and most of the EM currencies we monitor for the purposes of this report. The dollar weakened against the euro and the yen, while strengthening against the pound. All five of the commodity currencies we monitor depreciated on the day. All but one of the EM currencies we monitor for the purposes of this report depreciated on the day. The exception was the IDR which appreciated. The rand was the worst-performing currency in the commodity currencies category and took up the middle to lower position in the EM currencies category (beating only the TRY, the BRL and the RUB). The rand traded between a low of USDZAR10.6456 and a high of USDZAR10.7671. Support from where the rand opened this morning sits at 10.7200, 10.6800, 10.6250, 10.5800 and 10.5200. Resistance levels sit at 10.7800, 10.8200, 10.9000, 10.9400 and 11.0000.

Turning to commodity prices, Brent rose by 1.9%, and gold and platinum both rose by 1.5%. Copper meanwhile fell by 0.2%. The ALSI fell by 0.6% and the EM MSCI fell by 0.4%. The EMBI spread widened by 11 bps and the SA CDS 5yr spread widened by 2 bps. The CBOE VIX index, a volatility proxy for global risk appetite/aversion, rose by 32.2%.

Non-residents were meaningful net buyers of local equities (ZAR892 million) and were net buyers of local bonds (ZAR670 million) on the day. Buying was seen in the 12+ (ZAR1 087 million) and 7-12 (ZAR457 million) year buckets. Selling was meanwhile seen in the 3-7 (-ZAR864 million) and 1-3 (-ZAR11 million) year segments. Bond yields fell on the day by between 0.5 of a bp (R203) and 7 bps (R214). The 6x9 FRA fell by 2 bps, while the 12x15 FRA rose by 3 bps and the 3x6 FRA remained unchanged.

In local labour news, as an update on the strike in the metals and engineering sector (which began on 1 July), Numsa and employer groups are due to meet this weekend in order to find a resolution to the strike. The Seifsa and Neasa still disagree on the offers though; with Neasa sticking to an 8% increase, and Seifsa offering a 10% raise. Neasa believes that Seifsa’s bigger increase would “squeeze small players out of the sector”. Thus the two employer groups will meet today in order to guarantee that they enter discussions with Numsa in unison. Labour officials will still facilitate discussions between Numsa and Seifsa, which could see parties settle for a 10% wage increase. The threat of a “wage-price spiral” seemed to be particularly front of mind at the SARB’s deliberations this week. The trend in wage settlements are seen as posing an upside risk to the inflation outlook which is “likely to intensify”. As always some of this rhetoric around wage settlements likely represents jawboning. Yet, the Bank’s tone in this regard has become particularly shrill – at the last meeting no explicit mention was even made of concerns over a wage-price spiral. And the reason the Bank has seen fit to emphasis this point is that these trends in wage settlements do reflect the very real threat that inflation expectations could become unmoored, or in the worst case are already – although there is some comfort in the surveyed measures of inflation expectations that the latter is not yet the case.

FI

After yesterday’s MPC hike, we expect the market will take a slight breather this morning to digest the SARB’s move. EM risk is arguably skewed to the negative side today. The reported shooting down of the Malaysian airline flight is likely to see increased worries over the Eastern European situation, while the middle east situation is looking more volatile after Israel moved ground troops into Gaza.

Despite far lower growth forecasts, the SARB hikes the repo rate by 25 bps to 5.75%, in line with our expectations. What was perhaps a surprise is the SARB’s large cuts to their growth forecasts, now at 1.7% for 2014 (from 2.1%) and 2.9% for 2015 (from 3.1%). The weaker growth forecasts were countered by slightly higher inflation forecasts, with 2014 and 2015 inflation both up by 0.1pp to 6.3% and 5.9% respectively. The Q4:14 peak is now also forecast 0.1pp higher at 6.6%. The voting pattern of 1 – 5 – 1 (no hike – 25 bps – 50 bps) is a significant shift from the May meeting’s 5 - 2 (hike – no hike) voting split. The FI market reaction to the hike would suggest that the move was largely priced in. Apart from little moves in the very front-end of the curve, bonds rallied yesterday, a move counter to what conventional rate hike wisdom would suggest. The R209 and R2037 led the moves, strengthening by 8 bps. The benchmark R186 moved 6 bps stronger, with the front-end curve bull flattening by 7.5 bps, while the belly and back-end rates bull-flattened by 1.5 bps each. We would argue that the strong moves in bonds argues for (1) 25 bps having been priced in, (2) the market potentially believing that the 25 bp hike is a sign of a slowdown to the SARB’s hiking cycle and (3) that continued offshore demand in the long-end of the curve is likely to curtail any sell-off in that part of the curve.

At today’s ILB auction, NT is planning to raise up to ZAR800m across the I2025, I2038 and I2046. Interest in the auction today will be viewed in response to the SARB’s higher inflation forecasts yesterday and could see good demand for the shorter-maturity bonds. Following Tuesday’s nominal SAGB auction, NT raised an additional ZAR1.18bn through the non-competitive bidding process yesterday; this represents a full take up of the allowable 50%, with each bond raising their respective limits. An additional ZAR601m was raised in the R2030, ZAR401m was raised in the R2032 and ZAR175m was raised in the R2044.

Non-residents were net buyers of nominal SAGBs yesterday, for a total of +ZAR670m, which provided good support to nominal SAGBs. Foreigners purchased a significant +ZAR1.09bn in the 12+ year segment due to inflows into the R186 (+ZAR481m), R209 (+ZAR253m), R213 (+ZAR196m), R2048 (+ZAR166m) and R214 (+ZAR120m); this was partially offset by net selling in the R2030 (-ZAR200m) within this category. Foreigners purchased +ZAR457m in the R2023 in the 7-12 year category. The large inflows into the mid- to extended-maturity bonds were offset by net selling in the 3-7 year (-ZAR864m) segment; foreigners sold -ZAR553m in the R208 and -ZAR386m in the R204.

News late yesterday of the Malaysian plane crash in the Ukraine saw a widespread and significant sell-off in EM currencies, which depreciated on balance. This brings geopolitical tensions between Ukraine and Russia back to the fore, which could see risky assets take strain in the coming weeks. The Russian ruble recorded the largest depreciation of 2.19% yesterday, followed by the Brazilian real (1.56%) and the Turkish lira (1.02%). The rand depreciated by 0.74% on the day. Other EM currencies to depreciate were the Hungarian forint (0.64%), the Mexican peso (0.63%), the Polish zloty (0.56%), the Thai bhat (0.25%) and the Indian rupee (0.07%). In contrast, the Malaysian ringgit strengthened the most across the EMs (0.35%) and the Indonesian rupiah strengthened by 0.10%.

EM FI markets that we monitor for the purposes of our reports weakened overall yesterday; however, the results were skewed by the significant sell-off in Russian bonds on the back of escalating geopolitical tensions. 5yr EM bond yields rose by 3.04 bps on average, and 10yr yields rose by 0.48 of a bp on average. Russia’s 5yr yield rose by 28.00 bps and the 10yr yield rose by 25.78 bps. Turkey recorded the second-worst performance, with the 5yr yield rising by 8.00 bps. SA’s FI market recorded a strong performance (second-best), with the 5yr yield declining by 2.40 bps, and the 10yr yield declining by 6.00 bps (and also outperformed relative to the EM average).

Yesterday, both the Central Bank of Turkey (CBT) and the SARB announced their decisions on their respective countries’ policy rates. While the SARB hiked the repo rate by 25 bps to 5.75%, the CBT eased monetary policy, lowering their one-week repo rate by 50 bps to 8.25%. This outcome was in line with the Bloomberg consensus expectations of surveyed analysts. In its official monetary policy statement, the Committee continued to characterise monetary policy and macroprudential measures as being “tight”, noting that “recent data point to a modest course in private final domestic demand”. The CBT has noted that it will closely monitor all factors surrounding inflation and will maintain a flat yield curve “until there is a significant improvement in the inflation outlook”.

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