MPC today, as FOMC's "considerable time" stays

With USDZAR moving back above 11.00 after the FOMC statement confirming that rates would stay near zero for “a considerable time”, and the higher than expected SA CPI inflation print yesterday, SA bonds are likely to open slightly weaker this morning. However, moves should be constrained ahead of this afternoon’s SARB MPC meeting. Bond rallied aggressively yesterday despite the higher than expected inflation print because EM sentiment had improved prior to the FOMC meeting.

August CPI surprised the market to the upside yesterday, at 6.4% y/y, up from July’s 6.3% y/y and above both our call of 6.1% and Bloomberg’s 6.2%. Also, core CPI ticked slightly higher to 5.8% y/y from 5.7% y/y, with consensus at 5.7%. As we said yesterday, there was little reaction from the currency at the time, with USDZAR trading in a 10.90-10.95 range prior to the FOMC, but there was an aggressive rally from bonds.

At the start of this week, we noted three key risks to our baseline call regarding today’s MPC outcome. The first was the outcome of the FOMC meeting in the US. The second, a material depreciation of the rand which depends to a significant extent on what emerges from the FOMC meeting. The third, a material upside surprise in the August CPI inflation number. We have now seen an upside surprise to CPI, and the rand has moved back above 11.00 after the Fed’s FOMC statement, but has not aggressively sold off. This arguably increases the risk to the SARB hiking, and makes for a closer call today. Key will be any revisions to the SARB’s growth and inflation forecasts, particularly whether inflation is still expected to peak in Q4.

The Fed statement was quite mixed, with the reference to US interest rates remaining near zero for a “considerable time”, but the median forecast for the benchmark rate at the end of 2015 increasing to 1.375%, from June’s 1.125%. This suggests that the rate will increase faster than previously expected, but the method for reporting the median is slightly different. The median forecast for the end of 2016 is also higher at 2.85%, from 2.50%, and the newly introduced 2017 forecast puts the fed funds rate at 3.75% at the end of that year. The tapering of the QE programme continues, decreasing purchases of MBS and US Treasuries by $5bn/month. The final $15bn/month of purchases is expected to end at the next FOMC meeting in October.

However, in the post-FOMC press conference, the Fed chair noted that “I do feel we have the flexibility to move” and that “the statement is not some sort of firm promise about a particular amount of time” before increasing rates. This decision is still data-dependant. There were two dissidents: Dallas Fed President Richard Fisher and Philadelphia Fed President Charles Plosser. The Fed also gave some more information on the mechanism for raising rates; the interest rate that the central bank charges banks for depositing excess reserves at the Fed. The fed will then use the reverse repo facility to ensure that the effective fed funds rate and the interest rate paid to banks is kept in line. The policy rate will still be described in terms of a target fed funds rate, but will now be a target range of 25 bps. The reduction of the Fed’s balance sheet is likely to take some time and could take till the “end of the decade” to decrease the balance sheet “to the lowest levels consistent with the efficient and effective implementation of policy”. The local currency was quite volatile in an initial reaction to the statement, but ended up in a weaker trend and moving back above 11.00 against the US dollar.

The upside surprise in local CPI was largely due to the unexpected increase in food inflation, from 9.0% y/y in July to 9.5% y/y in August, and the increase in vehicle prices. SBGS economist, Kim Silberman, notes that “Meat inflation is rising defiantly, despite the fall in yellow maize. Meat inflation rose from 8.7%y/y to 10.1%y/y, adding 0.06ppts more to August CPI than in July”. Kim still “expect[s] food inflation to moderate, however the timing is uncertain, as the usual lags between raw commodity prices and food seem to have shifted”. More worrying perhaps is that core increased to 5.8% y/y, the third consecutive month that core inflation has ticked higher. While the petrol price was unchanged in August, it led to petrol price inflation falling to 5.7% y/y, from 8.3% y/y in July. Kim notes that going into September, “the price of petrol fell to R13.41” and “petrol inflation fell to 1.05%y/y. Petrol inflation on its own will reduce inflation by 0.26ppts to 6.16%y/y in September”.

With rand having broken through the key 11.0000 resistance marks, plus a few more north of that, we would acknowledge that there is a now a crack in the ‘technical’ ceiling, which increases the risk that the rand could move closer towards its January high of 11.390. However, it is not clear how much more concerned the SARB is about the exchange rate than it was in July, to the extent that the trade-weighted exchange rate has lost less ground. Furthermore, international oil prices have plummeted, and soft commodity prices (using The Economist food price index as a proxy) are also moderately down in dollar terms versus the time of the last MPC meeting following a dramatic fall commencing in the late stages of April.

US CPI surprised to the downside, with both core and headline printing at +1.7% y/y, against consensus of +1.9%. There was a large -2.6% fall in energy prices, which caused month-on-month CPI to fall by -0.2%, below the 0.0% consensus. Steve Barrow, Head of G10 Strategy, notes that a large number of sub-components were benign, with the data overall quite low.

Turnover in the local FI market was ZAR21.5bn, higher than the prior day’s auction stats. The R186 and R208 accounted for more than 52% of the turnover, with the R203 and R207 accounting for a further 16%. The rally in bonds came as EM sentiment improved on the day. Moves stronger were led by the R2023, with an 8.5 bps move, while the benchmark R186 moved 6.0 bps stronger. The moves were counter to the worse than expected inflation. The R158 and the R159, at the front of the curve, were the only bonds to weaken on the day. FRAs, however, ticked slightly higher, arguably in response to the higher than expected inflation print.

At today’s non-competitive bond auction, the 100% auction limit will still apply to the R2044, which has ZAR7.72bn outstanding (following the 16 September weekly government bond auction). This is less than the primary dealer ZAR10.00bn market-making minimum amount. The 50% limit will apply to both the R2032 and the R2048.

Non-residents were net buyers of nominal SAGBs yesterday for a total of +ZAR766m. Net buying was recorded in all four maturity categories. Foreigners purchased +ZAR235m in the 3-7 year segment, with buying seen in the R208 (+ZAR476m); this was offset by net selling in the R207 (-ZAR192m) in this category. +ZAR252m was purchased in the 12+ year segment due to pockets of buying recorded in six out of the nine bonds comprising this category, with the only notable inflow (in excess of +ZAR100m), recorded in the R2048 (+ZAR114m) on the day. The 1-3 year category recorded net inflows of +ZAR207m, with a notable +ZAR126m purchased in the R203. For the second day in a row, there was unusually low foreign interest in the R186.

Bloomberg is reporting that South Africa placed $500m in its debut Sukuk issue. The 5.75 year note was placed at a yield of 3.9%, with 59% of investors reportedly from the Middle East. Business Day is reporting that National Treasury has said that the current ZAR466bn of guarantees that have been given to state-owned-entities is reaching the limit of what would be considered fiscally prudent. The ZAR466bn excludes any additional guarantees that might be given to Eskom under its new financial deal.

Yields across the US Treasury curve increased yesterday following the FOMC meeting. At the short-end, the 2yr UST rose by 3.24 bps to 0.57% and the yield on the 5yr UST rose by the largest increment of 5.67 bps to a yield of 1.83%. At the longer-end, the 10yr UST note increased by 2.74 bps to 2.62%, while the 30yr note rose by the smallest increment, of 0.86 of a bp to 3.37%.

A general improvement in EM sentiment yesterday saw EM FI markets close stronger. However, most EM markets closed prior to the FOMC meeting, suggesting EM FI may open slightly on the back foot this morning. EM currency markets did sell off following the Fed’s FOMC meeting. EM currency markets that were not open at the time of the FOMC statement’s release, sold off this morning.

In EM FI markets, 5yr local currency sovereign yields fell by 3.96 bps on average, and at the long-end, 10yr yields fell by 3.23 bps on average. SA’s FI market recorded a strong performance, and outperformed relative to the EM average, with the 5yr yield falling by 6.20 bps and the 10yr yield falling by 5.70 bps. Larger moves stronger were recorded in Russia (-12.66 bps) and Poland (-7.00 bps) in the 5yr space, and in Russia (-11.78 bps) in the 10yr space. All the EMs we monitor recorded stronger moves in their respective FI markets yesterday. Russia’s Finance Ministry cancelled its weekly OFZ bond auction yesterday, citing “unfavourable market conditions”.

The rand recorded the largest depreciation relative to the EM currencies that we monitor for the purposes of our reports. The rand depreciated by 1.14%, with most of this depreciation recorded in the wake of the Fed’s FOMC meeting. However, depreciation was broad-based across the EM markets, with only the Indian rupee and Indonesian rupiah appreciating on the day. However, these markets were closed at the time of the Fed’s meeting, and have since depreciated substantially, in line with the selloff seen across other EM currencies. The Brazilian real recorded a 1.12% depreciation and the Turkish lira depreciated by 0.94% yesterday. The Polish zloty and the Mexican peso depreciated by 0.94% and 0.76%. The Hungarian forint (0.55%), Thai baht (0.31%) and Russian ruble (0.26%) also depreciated notably on the day.

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