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Today’s Talking Point

CPI y/y: Apr

Expected: 7.0%

Prior: 7.1%

Analysis: Globally, a theme of easing inflation is playing out but domestically, idiosyncratic factors are keeping price pressures elevated. A weaker rand, the cost of mitigating load-shedding and other infrastructure failings, together with enormous electricity tariffs are all factors driving a slower-than-expected fallback in inflation. This month, the rand's vulnerability was on full display, and the SARB will be cautious of the pass-through impacts on prices. Fortunately, oil prices have declined, which will help ease the pressure off SA's key input costs. Consensus expectations suggest that headline inflation is expected to have declined slightly in April. Fuel inflation will likely fall for statistical reasons linked to a high base a year ago, while food prices will remain elevated. Core inflation (which excludes these volatile food and energy prices) remains under pressure as delayed price increases filter through into the general economy and is expected to have risen in April.

Rand Update

Leading indicator stats published yesterday underscored the tough decision that lies ahead for the SARB tomorrow. The index fell from 120.2 to 117.8 in March, still pointing towards a downturn in economic growth. Unfortunately, there are few reasons to expect any short-term improvement in the leading indicator. In contrast, reasons for further weakness are clear: slowing global growth and long-term structural weaknesses domestically form the backdrop to a cost-of-living crisis (which has stifled demand), a weak labour market, and rapidly rising input costs due to load-shedding and other public infrastructure failings.

Looking ahead, the clear risk is the expected peak electricity demand in the upcoming winter. Eskom itself expects Stage 8 load-shedding, with risks predominantly to the upside. These massive levels of load-shedding will be calamitous to economic production, forcing a further downward revision to expected economic growth - not just for 2023 but into 2024 and 2025.

While there is no risk of the economy overheating, so, too, demand-side disinflationary pressures are growing stronger in SA. April CPI data scheduled for release today will likely reflect this, with consensus expectations as per Bloomberg surveys pointing to a drop in headline inflation from 1.0% m/m to 0.5% m/m and from 7.1% y/y to 7.0% y/y. However, risks are tilted to the topside, as a weaker ZAR, the cost of mitigating load-shedding and other infrastructure failures, and enormous electricity tariffs drive a stickier-than-expected slowdown in inflation.

It is precisely these nuances that the SARB will focus on when it updates SA's monetary policy tomorrow. It will be particularly cautious of a weak ZAR's pass-through impact on prices down the line. So while today's CPI data are extremely important ahead of tomorrow's policy update, a disinflationary print will likely not be enough to change the SARB's mind.

The ZAR continued to outperform its emerging-market peers on Tuesday, recovering a further 0.20% of its value against the USD, 0.60% against the EUR, and 0.25% against the GBP. As investor sentiment stabilises, the market is increasingly looking for a catalyst to trigger the ZAR's next move higher. That may well come in the form of an aggressive rate hike by the SARB this week. There is a lot of bad news priced into the local unit at current levels, suggesting some scope for recovery remains. However, should the SARB disappoint by hiking by a smaller increment than what is currently expected, the ZAR's ongoing rally would reverse. There is thus plenty of two-way risk in the immediate short term, with all eyes on the SARB.

Bond Update

Bonds/Yield Curve: Foreign investors have been selling South African bonds this year, with outflows totalling $1.4 billion in the last five months, exceeding last year's total outflow of $1.1 billion. The pressure on local bonds is attributed to various factors, including the greylisting, Eskom's revelations and its ongoing power cuts, a recent dispute between Washington and Pretoria over Russia relations, and a weakening rand.

There is plenty of risk factored into SA bonds and yields, so once investors are convinced of the shift in the monetary policy cycle, demand will likely return. There has been a significant widening in the yield spread between SA and US 10-year bond yields. The spread has widened out to almost 870bp, with the generic 10yr SA yield at 12.435% and the US 10yr yield at 3.745%. This spread is set to widen a lot further as US rates moderate on a US debt-ceiling deal and a pivot in US monetary policy, and that too will be a factor supporting the ZAR. Against this backdrop, a bold hike tomorrow by the SARB, coupled with signs of inflation moderating, should entice some investors to reconsider SA bonds as a speculative investment proposition.

Not that demand at yesterday's vanilla bond auction was bad. All things considered, they were decent ahead of today's inflation data and tomorrow's anticipated rate hike. Cover ratios may have been slightly below their five-auction average but appear to be tentatively stabilising. That will come as some relief to National Treasury that tip-toed back into extending the duration at the latest auction. The bonds cleared without any problem, and it was notable that clearing yields on the R2035 and R2037 settled a little lower than prevailing market rates.

FRAs: FRA rates at the very short end appear to have stabilised and should stabilise even more should today's inflation data dip below 7.0% y/y. The SARB is expected to hike by at least 50bp and could even move by 75bp, depending on their interpretation of inflation. So should inflation surprise the downside, the market is ripe to attract some receiving interest, given how aggressively the entire curve has been paid higher in recent weeks. The middle to longer end of the FRA curve continues to drift up as investors position for interest rates remaining higher for longer, with the inflection point in rates now pushed out to the start of 2024, and that will only be if inflation makes a material and sustained retreat. The 9X12 vs the 1X4 spread remains wide at 66bp, and that's on top of a 1X4 trading at 8.60%, well above the current repo of 7.75%.

Repo: The SARB will likely hike by a minimum of 50bp tomorrow to stabilise markets. This is not what forecasters or the SARB had in mind, but there was panic in the market recently, and bold decisions are needed. Any expectations of rate cuts early in 2024 have now disappeared, and all eyes will be on whether the ZAR makes a full recovery or not. The ZAR is vulnerable, which may even prompt the SARB to remain hawkish, although an intra-meeting emergency hike is no longer looking as necessary. The peak in interest rates priced into FRAs has now moved 100-125bp higher but could stabilise around current levels ahead of the SARB decision and statement next week.

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Research Team
Media, Sasfin Bank