Executive Summary:

After Brazil, SA has the highest CDS spread when compared to its closest EM peers. However, EM spreads on average have been trending lower since 2016 and accelerating to the downside YTD. Much of the compression in EM and SA CDS spreads can be explained by the easier global financial conditions

Currently, local risk premiums remain highly compressed. The CDS spread, local bond yields, and the USDZAR have all declined or strengthened post the downgrades. Foreign buying of local bonds remains strong. In our view this trend may persist due to the yield-seeking, risk-on environment that we find ourselves in.

Local growth is expected to remain benign, while inflation will likely remain below the 6% upper band over the next 12 to 18 months. We anticipate further yield and CDS spread compression up until we reach an inflection point (which may be induced by a change in foreign investor sentiment away from the current yield-seeking behaviour).

The SARB remains concerned about the trajectory of the rand – any flare-up in political risks could hamper the rand exchange rate, which may feed through to headline CPI. However, despite this concern, the SARB did begin a loosening cycle in July 2017 as inflation has declined, the rand remains relatively stable through the turbulence of 2017, and domestic demand-pull inflation remains absent. As a result, we believe the SARB will provide two more rate cuts of 25bps each by 1H18 in the current cycle.