With the JSE trading at near-record levels even amid ongoing global concerns about everything from possible stock market bubbles, accelerating inflation and geopolitical tensions between the US and China, armchair investors might be tempted to take some risk off the table by switching their portfolios into the comparative safety of the money market.
However, after speaking to Allan Gray fixed income portfolio manager Thalia Petousis they might want to instead consider longer-dated government bonds as a safe haven or even continue chancing their luck in equities. Despite the market pricing in rate hikes at every monetary policy meeting between now and the end of 2023, Petousis says the hawkish rate sentiment is overblown as the Reserve Bank may turn out to be less aggressive in tightening borrowing costs.
Two-year forward rate agreements (FRA), a type of futures contract for three-month interbank lending rates that give an indication of where borrowing costs are heading, show traders are betting the repo rate will be at about 7% by end-2023. That is even more bearish than the monetary policy committee’s (MPC’s) quarterly projection model, which suggests the central bank will hike rates by at least 25 basis points at each of its meetings between November 2021 and end-2023.
While the MPC only uses the quarterly projection model as a guide and does not necessarily act on it, rising fuel prices, ongoing global supply chain bottlenecks and a weaker rand have precipitated a crescendo of warnings that a lengthy rate hiking cycle is about to begin. However, Petousis says investors should not assume that SA policymakers will be in a hurry to unwind the series of rate cuts that sent the repo rate to a more than five-decade low in 2020.
“The market is pricing in a very aggressive hiking cycle but it is clear the market is on one planet and central banks are on another,” Petousis told Business Day. “The local FRA market is dominated by foreign positioning which is always quicker to throw the baby out with the bathwater. SA’s inflation is still fairly comfortable at 5% which means we are not in as dire a position as some other emerging markets.”
Weak domestic economy, which is placing strain on domestic consumers, may hinder the Bank’s ability to hike rates
— Thalia Petousis, Allan Gray fixed income portfolio manager
Nevertheless, inflationary pressures are beginning to build thanks to a combination of rising oil prices, a weaker rand and the surging cost of food. SA’s government announced sharp hikes in petrol and diesel prices at the start of this month in response to oil trading at seven year highs above $80 a barrel. Combined with a weaker rand that could stoke additional inflationary pressures that have driven the average household food basket for low-income households above 10% in October, according to a recent affordability survey by civil society initiative the Pietermaritzburg Economic Justice and Dignity Group.
Yet Petousis says SA’s weak domestic economy, which is placing strain on domestic consumers, may hinder the Bank’s ability to hike rates, particularly since it is not consumers driving inflation. Her only caveat is that this assumes the rand does not slump dramatically from current levels of about R15/$.
“The Bank will definitely have to hike but I’m not sure they’ll move as early as November,” she says. “By the middle of next year I think repo will be closer to 4.5% and by the end of 2023 we’re likely looking at it being somewhere between 5% and 6%.”
What that suggests is that money market fund rates are not likely to move materially higher than their current levels of about 4.5% over the next few months to a year, which means their negative post-inflation returns are likely to persist for some time. SA’s longer-dated bonds, with nominal yields of around 11%, offer much higher real returns over time if investors have the risk appetite to stomach potential capital losses over shorter periods.
“If you’re lucky you’re getting 4.5% in the money market so with inflation at 5% you’re essentially locking in negative rates,” says Petousis. “While the gap between the money market and longer dated bonds will narrow as rates rise, it will take quite some time for the money market to start looking attractive again relative to bonds. Even if the money market gets to 6.5%, with longer dated bonds offering 11% it’s still quite a material gap.”
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