The recent 50 basis point rate increase in South Africa has had mixed responses across the board, but none more so than among foreigners, who have seemingly started voting with their feet.
Brait economist Colen Garrow says non-residents have been sellers of equities for four consecutive days now, and this needs to be monitored.
Garrow told I-Net Bridge that while it was not aggressive selling, it was a trend to watch very carefully. “Do foreigners now believe the whole asset class is contaminated?” Garrow asked.
He said the two main factors he considered were the drop in equity activity and the widening of the spread on South African bonds relative to US bonds.
“I looked at the yield compression on the R157 and the 10-year US treasuries and noted our yields were going up while theirs were going down. This makes sense, indicating that our interest rate cycle is starting to rise and theirs indicates slower growth. This makes a more solid case for the flight to quality we’re seeing,” he said.
Garrow mentioned that there were net sales of R535-million by foreigners during the course of last week, which, while insignificant relative to the R54-billion purchased in the year to date, was enough to start raising some alarm bells.
“It is the quality rather than the quantity of capital flows financing the deficit on the current account of the balance of payments which is causing concern. Short-term portfolio capital, bought by foreigners on bond and equity markets, generally provide unreliable financing of shortfalls on the balance of payments. Flows through the equity market, for instance, are attracted by prospects of higher trending GDP growth.
“Higher interest rates would not only curb GDP growth, but would affect non-resident activity in the equity market,” he said.
Garrow summed up by saying that risk aversion towards emerging markets continued, which was reflected by the price movements in the currency baskets. He mentioned that economies with high current account deficits had seen their currencies sold off, with the rand, the Turkish lira, the Iceland krona and the New Zealand dollar all in the basket of ten worst performing currencies measured against the US dollar this year.
A senior bond dealer told I-Net Bridge he had also noted the widening of the emerging markets bond index spread, which acknowledged the risky status of emerging markets.
“This is a continuation of the carry unwind trade. We have Japan raising rates and the US close to peaking, whereas a few years ago we had huge carry trades with US rates at 1% and 2%. It was cheap to borrow and invest in countries like SA with rates of 12%, but now this is unwinding.”
“Emerging markets are therefore coming under pressure as this unwind happens and it is affecting the net inflows,” the dealer said.
“We can also see in the gold price that investors are nervous [gold was last at $592/oz from $604,25 on Monday]. There is short-term market risk, but there is potential for a bounce. I feel two thirds, 66%, has already happened,” the dealer said.
It is interesting to note that foreigners sold in tranches of R316-million and R720-million in mid March. They have now sold off R535-million during the course of last week. – I-Net Bridge