SARB Repo Rate
Analysis: The SARB responded aggressively in March to persistently high price pressures and concerns over the risk of rand-weakening capital outflows with a 0.5% rise in interest rates. Initial expectations for May's decision were for a 0.25% hike, but these expectations have been upgraded in light of the recent rand sell-off. The SARB is aware of the pass-through risks of a weaker currency on imported products – especially fuel. A firm rate hike can work to stabilise these outflows. The SARB will find support for a higher interest rate in the reality that it has fallen behind other EM countries' pace of hiking and needs to play 'catch up'. Further hikes are on the cards beyond this week's expected 0.5% hike; another 0.25% in July should be anticipated, with rate cuts being pushed out to H2 2024. However, if the rand remains at such weak levels, these expectations will need to be upgraded further.
Today will be a pivotal day for the ZAR. The SARB's policy decision and accompanying forward guidance will be key in determining the local currency's near-term direction. While CPI data published yesterday showed that price pressures in SA are softening, the data are unlikely to have much bearing on the SARB's policy decision today. The SARB's focus will be on defending the currency so as to avoid higher import inflation down the line.
South Africa has been subject to significant capital outflows in recent weeks as tightening global financing conditions have led the market to punish the country's deteriorating risk profile with some severity. Interest rates need to rise to balance out SA's less attractive investment optics and attract capital back to its shores. Accordingly, an outsized 50bp rate hike is expected today, with anything less than that likely to be insufficient to arrest the ZAR's inflation-stoking slide.
So while it is certainly true that SA's damaged economy can do with some reprieve, supporting economic growth is second to fighting inflation in the SARB's mandate. Specifically, the SARB's job is to protect the value of the currency in the interest of economic growth, with the erosion of the currency's value in the form of inflation viewed as an extra tax on the economy. Instead, it is the government that needs to foster an environment conducive to economic growth, which it has failed to do for the better part of the last decade. All that to say that while an outsized rate-hike may be difficult to stomach, it is necessary to fight second-round inflationary pressures down the line.
Market sentiment has taken a turn for the worse after ratings agency Fitch put the US' AAA credit rating on watch for a possible downgrade, raising the stakes as talks over the country's debt ceiling go down to the wire. Naturally, this has weighed on the ZAR as investors rotate towards safety. The currency also faces notable two-way idiosyncratic risk, with all eyes on the SARB's policy update today. Should the central bank hike rates aggressively, the ZAR may have a go at R19.0000/$ again in the coming days. Conversely, a rate hike deemed too small by the market will likely reignite the ZAR's bear run and could see it test R19.5000/$ into the weekend.
Bonds/Yield Curve: Although the move in the ZAR was not sustained, it was still interesting to note the gains achieved in the bond market yesterday on the back of the ZAR testing levels closer to 19.12/dlr. SA bonds are ripe for a recovery, and yesterday's inflation data also encouraged bond market bulls back into the market as they look towards further moderating inflation through the months ahead. Although core inflation remains stubbornly buoyant, headline inflation will continue to decline.
The SARB's decision and accompanying statement will be key to how bonds perform today. Yesterday saw rate hike expectations moderate fairly significantly based on the inflation data and the stronger ZAR. Any indications today that the SARB will do all it can to moderate inflation and investors will likely look through the final phases of monetary tightening to target lower inflation and lower interest rates. A lot is already priced into SA bonds, which will stand the bond market in good stead.
As it is, the spread over US Treasuries widened out earlier this week to the highest levels in approximately nine months. That narrowed slightly yesterday, but given the trajectory of the SARB vs the Fed, there is no doubt that the spread will widen back out again in the future. The same can be said for the spread of short-term interest rates over the equivalent US interest rates, implying that the forward points are widening and making it more expensive to speculate against further depreciation in the ZAR. The inflection point in the cycle is near.
FRAs: Finally, some receiving interest was noted across the curve yesterday thanks to the softer-than-expected inflation data that prompted a revision in interest rate expectations. Whereas the market was pricing in the prospect of 150bp worth of rate hikes in the months ahead, that has now moderated back towards 125bp, although the move remains contingent on the ZAR not blowing out any further. Today's SARB decision and statement will be key to determining direction. A firm commitment towards reducing inflation may keep FRAs elevated around current levels, but investors will know that tougher decisions upfront will assist inflation moderate a little faster, and the cycle might therefore reverse quicker too. Anticipate more curve flattening should the SARB reinforce its commitment to reducing inflation through bolder short-term rate hikes.
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.