SARB cautious, but likely to cut rates again - analysts

Cape Town - The SA Reserve Bank (SARB) is likely to cut interest rates again, but will be cautious and sceptical that the favourable global conditions will last, according to Dave Mohr (chief investment strategist) and Izak Odendaal (investment strategist) at Old Mutual Multi-Managers.

Though second quarter economic growth is likely to be positive, the economy is still weak and the repo rate of 6.75% (2% in real terms) too high, in their view.

Although interest rate cuts will provide some relief for indebted consumers, they point out that they are unlikely to spur much new borrowing given depressed confidence levels.

Bonds

Bonds should benefit from declining inflation. Since bonds pay out a fixed coupon over the life of the bond, while returning the initial capital at maturity, bondholders are very exposed to inflation eroding the real value of their investment, according to Mohr and Odendaal.

Nominal bonds, therefore, tend to rally (yields decline) when inflation is expected to decline. Cuts in short-term rates are a further shot in the arm since a long bond yield reflects the expected short-term rates over the life of the bond.

Political and ratings risk

However, political risk is weighing on bond markets, they said. It is touch-and-go whether Moody’s and S&P will further cut South Africa’s local currency ratings.

They explained that credit ratings usually matter less than commonly assumed, but in this instance further cuts would see local bonds removed from a key investment grade index, leading to forced selling by foreign investors who track the Citigroup World Government Bond Index.

In a favourable global environment, there would still be plenty of buyers of South African rand bonds even after a further downgrade, but how much would the yield have to move up to entice them? This will depend on what else is available.

Therefore, local political developments always have to be seen in a global context, said Mohr and Odendaal. While South Africa’s position relative to other emerging markets has deteriorated - due to politics, ratings and slow growth - the overall emerging market group has rallied over the past year, benefiting from a benign global inflation and interest rate outlook.

While alleged corruption at state-owned enterprises (SOEs) is grabbing headlines, along with the proposed bail-out of SAA, the biggest problem is simply that growth is too low. The local economy was hit by a number of shocks since 2013 - commodity prices, load shedding, drought, policy own goals), and confidence is very low as a result, said Mohr and Odendaal.  

Decoupled

Consequently, South Africa has decoupled from global growth, with the latter improving of late. While there is widespread evidence that the worst is over in terms of the growth slowdown - culminating in a technical recession - economic growth for the current fiscal year is likely to be lower than forecasted in February.

Lower-than-expected growth means tax revenues could undershoot budgeted amounts. In the absence of spending cuts or tax rate increases, Treasury would not be able to close the fiscal deficit as much as promised, and the overall debt level would not stabilise as quickly as promised.

As the ratings agencies have warned, the factional battles in the lead-up to the ANC’s elective conference in December means decisive policy interventions to stimulate growth are unlikely.

But it shouldn’t take too much for us to recouple with the global cycle if some of the dark political and policy clouds lift. Already tourism is growing nicely, and commodity prices have firmed up.

Since none of this is new, it should be largely reflected in the price of local assets, according to Mohr and Odendaal.

The start of the year saw shorter dated bonds rally till now, reflecting the improved inflation outlook. But longer dated bond yields have risen marginally in response to the uncertain political outlook.

The 5-year bond yield rallied from 8% to 7.5%, but the 20-year yield drifted up from 9.4% to 9.5%.

They said these are attractive real yields in a context of a diversified portfolio where other assets - like SA and global equities - provide protection should the political uncertainty not improve after December and the fiscal situation deteriorates more than expected.

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