By Brian Kantor
It was a good week for emerging markets (the MSCI EM up 4.4%) and the rand (which gained nearly 4% on a trade weighted basis) last week. It was an even better week for off shore investors in the SA component of the EM benchmark (MSCI SA) that had returned as much as 8% in US dollars by the weekend. On a trade weighted basis the rand is now about 18% down on its value of a year ago.
The response of the RSA bond market to the stronger rand was also consistently favourable. The yield gap between conventional RSA bonds and their inflation-linked alternatives narrowed to 6.1%, indicating less inflation expected, while the yield gap between RSA 10 year bond yields and the US 10 year Treasury bond also narrowed to below 4.9%, indicating a slower rate at which the rand is priced to weaken over the next 10 years. This breakeven exchange rate weakness may be regarded as a measure of the SA risk premium. It would take an extra 4.9% in rand income to justify an investment in rand denominated assets of equivalent risk, rather than US assets.
The rand and the rand bond market benefited last week from strength in emerging market equity and bond markets as US bond yields retreated from their fear of the end of QE spike last week. It should be appreciated that the bond market moves the week before in the US and elsewhere were of an extraordinary dimension –an apparent overreaction to a promised return to something like normal in the fixed interest space.
The partial recovery of the rand portends less inflation and the developments in the RSA fixed interest markets were consistent with this. Any further strength of this kind would convert premature fears of higher short term rates in SA into expectations of lower short term interest rates. The SA economy deserves lower borrowing costs and a stronger rand would make this possible. Better still for the rand would be less disruption of output on the mines than is currently expected (and priced into the rand).