In today's market update, given that the preliminary data has already been released, the Eurozone’s final February CPI reading is unlikely to market moving unless there is a significant revision in the number.
EZ CPI y/y: Feb F
Expected:
Prior: 8.60%
Analysis: Given that the preliminary data has already been released, the Eurozone’s final February CPI reading is unlikely to market moving unless there is a significant revision in the number. The preliminary reading underpinned the notion that inflation in the shared block has peaked and is trending lower. While the headline inflation number remains buoyed well above the ECB’s inflation target, if confirmed by the final reading, annual inflation slowed for the fourth straight month in February, falling to 8.50% y/y. While policymakers will take some comfort in the fact that headline inflation is decelerating, it will worry them that core inflation continues to trend higher. Until core inflation turns a corner and shows signs of a sustained retreat, we are unlikely to see the ECB lift its foot off of the tightening pedal.
As we head into the end of what has been a volatile week to say the least, the ZAR is trading back where it started just south of the R18.5000/$ mark. The market has had to navigate treacherous trading conditions as the US financial sector came under pressure with the failure of some mid-cap banks. As is now widely known, US authorities stepped in with emergency backstop measures to shore up liquidity and confidence in the banking system, but this led to the reversal of around half of the Fed’s balance-sheet shrinkage since it began its quantitate tightening programme in June last year. All this speaks to a fragile banking sector under significant strain, which will make for some interesting debate at the Fed’s policy meeting next week.
Interestingly, the ECB shrugged off the ongoing market turmoil as it hiked its benchmark interest rates by 50bps yesterday. It was the first major central bank tasked with weighing recent banking sector turmoil against still high and sticky price pressures, and opted to bolster its inflation-fighting credentials as it argued that Eurozone banks were resilient enough to withstand recent stress in the market. However, its lack of policy guidance suggested that it may slow its pace of monetary tightening through the months ahead, especially if financial instability becomes more entrenched. Whether the Fed, BoE, and SNB – all scheduled to provide monetary policy updates next week – will follow in the ECB’s tracks remains to be seen, although it is unlikely as the ECB’s outsized rate hike seemed more like a desperate attempt to play catchup in tackling inflation.
Locally, the big news this morning is that the government has offered public servants a 7% pay increase for the next financial year. Notably, this was more than what was budgeted for in February, which will complicate Finance Minister Godongwana’s efforts to rein in debt and correct SA’s unsustainable fiscal trajectory. Labour unions, who are seeking a larger wage increase, have yet to accept the offer, and may continue to pile pressure on the government with continued strike action. On the whole, SA’s fiscal risks are once again in focus, which will weigh on the ZAR’s resilience at a time when global financial markets are turning increasingly volatile.
The USD-ZAR failed to break through 18.5000 yesterday, and is once again trading with a downside tilt as global market sentiment shows tentative signs of recovering. The pair looks set to end the week with nothing in the way of major gains or losses, and still trading at the mercy of external developments. Focus will be shifting to the major central bank meetings next week, which hold plenty of market-moving potential for the ZAR over the near term.
Bonds/Yield Curve: The situation in the US has calmed; the Fed is active again alongside the FDIC, while bigger banks have jumped at the opportunity to consolidate the banking system and grow. Systemic risk has decreased, and investors are looking to take advantage of cheaper risk markets. As US Treasury yields have nudged back up and the ECB rate decision boosted EZ bond yields, domestic bond yields have also nudged higher. They are likely to end the week very close to whether they started, although it is clear that the cycle has turned and broad-based interest rate expectations have changed. Fund managers will remain more inclined to persist with their long-duration positions and take advantage of the yields on offer, although they may need to remain patient. Today, the weekly ILB auction and the guidance on inflation expectations will be of interest. With US inflation moderating and a slowdown anticipated in the global economy, inflation expectations may well moderate, especially as oil prices are also trading in the mid $70s per barrel.
FRAs: FRAs have come in for some receiving interest this week and are expected to consolidate their recent moderation as investors look to the Fed next week for some guidance. The ECB may have hiked rates yesterday but were laggards in the monetary tightening world. The Fed's decision is more important for SA and will hold consequences given that the Fed is rebuilding its balance sheet. The Fed may soften its stance given that the FDIC has been forced to bail out depositors while larger banks are assisting some smaller banks to remain going concerns. The market has moved to price in one more 25bp hike with the prospect of more should the market calm down, but more clarity will come next week. In the run-up to that, more consolidation is likely.
Repo: Expectations for interest rates are very fluid at the moment. Last week investors were convinced that the Fed would need to hike aggressively and the SARB would follow. This week, much of that has unwound as investors consider the Fed's response to two bank failures in the US. Fewer hikes in the US mean less pressure on the SARB, and although one might still argue for another 25bp hike at the next meeting, more hiking beyond that is no longer obvious. The terminal peak in rates has been brought forward and lowered.
