Traders Blind to South Africa Rate Pressure May Be in for a Jolt

JOHANNESBURG (Capital Markets in Africa) – Fixed-income traders who have become complacent about interest rate increases in South Africa are setting themselves up for a “negative monetary surprise,” according to Nedbank Group Ltd. — and that could cost them.

The South African Reserve Bank will meet for this first time this year on Thursday, with all 18 economists in a Bloomberg survey predicting policy makers will hold the benchmark rate at 6.75 percent. But a hike could still be on the cards later this year, according to Nedbank, which is penciling 25 basis points in May or July to coincide with a probable U.S. Federal Reserve move.

Forward-rate agreements starting in 12 months, used to speculate on borrowing costs over the period, show investors pricing in just 13 basis points of rate hikes this year, down from as high as 44 basis points in December. That implies a 52 percent probability of a 25-point increase this year – too low, according to Nedbank.

“The local FRA market has turned too dovish,” Walter de Wet and Reezwana Sumad, Johannesburg-based analysts at Nedbank, said in a note to clients. “Relative to our base case, we believe the market is now more likely to experience a negative monetary surprise in the coming months. A negative monetary surprise would be consistent with negative excess bond returns.”

It’s true that pressure to tighten policy has eased since the central bank’s surprise rate increase in November. Inflation expectations as measured by the five-year break-even rate have moderated to around the lowest levels since March 2018, while the rand — a key driver of price increases — is at a one-month low. The global backdrop has become relatively benign too, with Fed officials signaling they may pause or delay rate hikes, and China pledging more stimulus to boost its economy.

But the picture could change towards the second half of the year, the Nedbank analysts said. Key to that view is the expectation that Moody’s Investors Service will cut South Africa’s local-currency credit rating to junk, sparking a foreign-investor exit from local bonds and weighing on the rand.

Yields on benchmark government bonds due December 2026 already trade below Nedbank’s fair-value estimate of between 8.9 percent and 9.1 percent. The yield dropped three basis points on Wednesday to 8.77 percent, and has been below 9 percent since December 24. That should be a warning to bondholders, De Wet and Sumad wrote.

“We read the current market stance as an environment where duration should be reduced rather than increased,” they said.

Source: Bloomberg Business News