Rand bonds revel as Marcus finesses policy

South Africa remains in a "tightening cycle" as the weak rand, high wage settlements and rising food costs pose risks to inflation, governor Gill Marcus said. (David Harrison, M&G)

South Africa remains in a "tightening cycle" as the weak rand, high wage settlements and rising food costs pose risks to inflation, governor Gill Marcus said. (David Harrison, M&G)

The biggest rally for South African local-currency bonds since March is a sign investors are becoming more confident in Reserve Bank Governor Gill Marcus’ efforts to tackle inflation without choking economic growth.

The yield on government bonds in rand due December 2026 dropped 16 basis points this month, reaching a two-month low on July 18. That’s the sixth-biggest decline out of 24 emerging-market nations tracked by Bloomberg. South African bonds have returned 1.8% in the period, compared with a 0.7% decline for emerging-market debt tracked by Bloomberg indexes.

South Africa remains in a “tightening cycle” as the weak rand, high wage settlements and rising food costs pose risks to inflation, Marcus said on July 17, after lifting the policy rate by 25 basis points, less than January’s half percentage-point jump.
The Reserve Bank had refrained from raising rates since then as the economy contracted in the first quarter partly because of a five-month strike at platinum mines.

“People have been concerned that they’ve taken their eye off the ball with regards to inflation,” Jean-Pierre du Plessis, a strategist at Prescient Investment Management, which oversees the equivalent of about $8.3-billion, said by phone from Cape Town on Tuesday. The 25 basis-point rate increase “won’t really put the brakes on the economy, but it sends a signal that they’re concerned about inflation,” he said.

Still hawkish
Inflation exceeded the central bank’s 3% to 6% target in April and May and the bank only sees the measure falling below the upper band in the second quarter of next year. Marcus predicted inflation will peak at 6.6%, the level it reached in May. The rate will average 6.3% this year and slow to 5.7% in 2015, according to the median estimate of 23 economists in a Bloomberg survey.

The central bank last week cut South Africa’s 2014 growth forecast to 1.7% from 2.1% estimated at the Monetary Policy Committee’s meeting in May, and lowered the forecast for 2015 to 2.9%. The bank didn’t factor in the effects of a three-week walkout by more than 220 000 metalworkers.

“The Sarb [South African Reserve Bank] is one of the few central banks that is still hawkish,” Asher Lipson, head of fixed-income strategy at Standard Bank Group, said by phone from Johannesburg. “There is a belief that the Sarb is still very credible.”

Ukraine crisis
The South African Reserve Bank was one of five central banks, along with Malaysia, Egypt, Ukraine and New Zealand, to raise borrowing costs since the beginning of June, while eight, including Turkey, Mexico and Chile, have cut rates, according to data compiled by Bloomberg. The move boosted investor confidence in South African assets amid increasing competition for funds as the Federal Reserve scales back its monetary stimulus, according to Lipson.

Global funds bought a net $515-million of South African bonds this month as the crisis in Ukraine spurred investors to look for high-yielding assets in less risky regions. That brought inflows this year to $1.8-billion.

“The rand is the geopolitical safe haven” among emerging markets in Eastern Europe, the Middle East and Africa, Benoit Anne, the London-based head of emerging-market strategy at Societe Generale SA, said in a July 21 note, recommending that clients buy rand against the Turkish lira and Russian ruble. “The rand has the benefit of a central bank that seems to care about exchange rate pass-through and inflation expectations.”

Higher rates
Future rate increases will depend on the outlook for growth and interest rates in the US and the euro region, as well as the inflation trajectory in South Africa, Lipson at Standard Bank said.

Forward-rate agreements, used to speculate on interest rates, are signaling another 44 basis points of rate increases this year. The yield on the December 2026 bonds rose five basis points, or 0.05 percentage point, to 8.17% by 4.40pm in Johannesburg on Tuesday. The rand strengthened 0.3% to 10.5380 per dollar at 9.22am.

“The market is comfortable that the SARB won’t do anything rash,” Lipson said. “A lot will depend on the next couple of inflation prints. We’re moving into a very data-dependent cycle.” – Bloomberg

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