The 50bps reduction in the Reserve Bank Repo rate came at a distinct and welcome surprise to the market – a surprise that saw the forward short term rates and long term bond yields decline significantly. The implicit inter bank rates (JIBAR) three and six months forward rates declined by about 40bps as did the Forward rate Agreement (FRA) curve as we show below. The six month JIBAR forward rates remains above the three month rate and the FRA rates remain above the JIBAR rates, indicating that banks are paying up for longer term money. We were correct in arguing that the Bank could not ignore the further deterioration in the SA economy.
SA Banks Forward Rate Agreements
Source: Bloomberg and Investec Private Client Securities
JIBAR Forward Rates
Source: Bloomberg and Investec Private Client Securities
That the long term yield remains flat indicates that the market believes that interest rates are likely to remain at current levels for an extended period of time. The implied one year rate in ten years time is little different from the current one year rate.
The RSA Yield Curve
Source: Bloomberg and Investec Private Client Securities
The rand was unmoved by lower interest rates
The trade weighted rand was largely unmoved by the surprise reduction in interest rates. The decline in long term yields saw inflation compensation in the bond market, the difference between vanilla bond yields and their inflation linked equivalents, decline marginally. The yield on the inflation linked R189 also declined.
RSA Bond yields and inflation compensation
Source: Bloomberg and Investec Private Client Securities
Trade weighted exchange rate (higher values indicate weakness)
Source: Bloomberg and Investec Private Client Securities
The market reactions make the point – more than inflation targets are called for – for lower inflation
Such favourable reactions in the money and currency markets and of inflation compensation should encourage the Bank to continue to look beyond inflation as the focus of its operations. The weakness of the domestic economy remains the threat to the ability of the economy to attract foreign capital to support the rand and help hold down inflation. The economy, despite the SA recession, continues to attract foreign capital at an extraordinary rate as capital has flowed into emerging equity and bond markets, commodity markets and resource companies on recovery prospects. The SA markets have received their share of these flows – hence the strong rand that has held its own against strong other emerging and commodity market currencies.
Much more than lower interest rates are called for to help the economy
Lower interest rates can help support the longer term growth outlook and the attraction of the SA economy to foreign and local investors. But much more than lower interest rates are called for if the SA economy is to compete effectively with other emerging and commodity market destinations for capital over the next year or two. Quantitative easing, that is an increase in the rate of growth of central bank cash supplied to the system, is called for urgently to encourage the banks to lend more freely especially to households. The grave weakness in household consumption spending has to be overcome if the economy is to prosper. We have called for the Reserve Bank to supply one year money to the banks of which they continue to appear short. We would repeat this call with greater urgency.
We also welcome any temporary increase in the fiscal deficit. This is the time for the SA government to put its strong balance sheet to work to help the economy and tax revenues to recover. Hopefully stronger markets for SA exports will also assist the recovery.