SA’s financial market gurus are warning that consumers should brace themselves for higher interest rates this year amid accelerating global inflation, which could put pressure on local prices thanks to a rand that may slide to R17/$ by year-end.
With US inflation having hit an almost 40-year high of 7% in December, banks including Goldman Sachs and Morgan Stanley are predicting at least four 25-basis-point rate hikes in the US in 2022. Analysts say that will pile pressure on the SA Reserve Bank to lift its rates to preserve the yield advantage of rand-denominated assets.
Though 10-year SA bonds due in 2032 yield 9.8% against just 1.78% for treasuries of similar maturity, the comparative safety of the dollar-based securities is likely to lure international investors away from higher yielding emerging market assets. That could put pressure on the rand even if the Bank lifts rates as well, particularly since SA economic growth is likely to slow in 2022.
“[Our] expectation is for at least one hike per quarter with risk to the upside,” said Adam Furlan, portfolio manager at Ninety One. “We feel we’re definitely looking at the rand trading north of R16/$ and closer to R17/$ by the end of the year.”
While the median estimate of a Bloomberg survey of economists indicates the Bank will institute just three 25 basis point hikes in 2022, lifting the repo rate from 3.75% to 4.5% by year-end, local analysts are far more hawkish. BNP Paribas senior economist Jeff Schultz forecasts five 25 basis points rate hikes at the Bank’s first five meetings this year, which would take the repurchase rate to 5% by year-end.
Money market futures, an indicator of forward looking interbank lending rates, are even more bearish and are pricing in more than two percentage points of cumulative rate hikes for 2022. However, Investec chief economist Annabel Bishop says these expectations are “likely overdone” and expects three hikes of 25 basis points this year.
“It would be quite aggressive,” she says. “The SA economy is still in a recovery phase, with unemployment very high.”
While higher interest rates would normally boost the rand’s appeal for carry trades, the strategy of borrowing in countries with low interest rates to invest in higher-yielding markets, rising US rates is likely to counteract the yield advantage of SA assets. While most US banks are pricing in three or four rate hikes from the Fed, JPMorgan CEO Jamie Dimon caused a stir last week when he said US policymakers could hike rates as many as seven times to curb inflation.
While Dimon did not specify a time frame for his US rates warning, the longer the Fed tightening cycle the longer the local one is likely to be as well. Allan Gray portfolio manager Sandy McGregor expects the Bank to move more or less in line with the Fed.
“SA interest rates will follow international rates on the way up,” he says, though he expects just one percentage point of rate hikes from the Bank in 2022.
Rising US yields could also further dim foreign appetite for local bonds, which suffered cumulative net foreign sales of R156.8bn in 2021. On the plus side for SA bonds is that inflation, which erodes their fixed interest payments, is likely to stay moderate. McGregor sees SA inflation averaging a rather benign 4.5% this year while Schultz expects 5%, still within the Bank’s 3%-6% target band.
Another positive for local bonds was the unexpected upgrade in Fitch’s outlook on SA’s credit rating from negative to stable in December. While the ratings agency kept its rating on local debt at BB-, three notches below investment grade, Bishop says the improved outlook will be positive for SA bonds “provided SA does not see fiscal deterioration”.
But it is that potential for fiscal deterioration that concerns McGregor, who says there is “huge” political pressure on the Treasury to introduce a basic income grant. He worries that could imperil the fiscal targets tabled in the medium-term budget policy statement in 2021.
“The recent elections have shown that the ANC’s support base has largely retreated to rural areas which are still very reliant on social grants,” he says. “Political decisions will have to be made on social welfare. Will the Treasury hold the line on the budget and more importantly, can they hold the line?”
The medium-term budget estimated a fiscal deficit of 6.6% of GDP in 2021/2022 and 6% of GDP in 2022/2023. However, Furlan says given the higher revenue collection expectations from the fiscus Ninety One expects both those estimates to come in lower by as much as one percentage point.
“This would be positive for bonds,” says Furlan, though he warns that public sector wages and state-owned entities pose a risk to those forecasts.
“The government is going to have to be really tough on public sector wages and state-owned entities if they are to achieve their targets,” he says. “Then there’s also likely slippage from social grants, especially if they implement a basic income grant.”
However, even the rather bearish Schultz expects an improvement in the fiscal deficit thanks to strong revenue collections. He’s calling for a deficit of 5.5% of GDP for 2021/2022 and says this will be supportive of bonds.
“Overall, we are constructive on SA government bonds in 2022 driven by this robust fiscal performance,” he says.
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