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SA’s ex-ante real policy rate becomes unattractive as expectations rise
Since the start of this year, South Africa’s (SA’s) ex-ante real rate has been roughly in line with the US’s. This is the longest period in which this has been the case. SA’s ex-ante real policy rate has almost always exceeded that of the US, providing an attractive real-rate pick-up for offshore investors to invest in SA. But this year, rising SA inflation expectations, slow increases in the FRA rate and expectations for an end to SARB’s hiking cycle have kept SA’s ex-ante real policy rate unattractive relative to the US’s. In contrast, US inflation expectations have fallen, while the Federal Reserve (Fed) has remained hawkish. This has shown up in a weaker currency [USDZAR -10,4% year to date (ytd)] and higher SA bond yields [(SA 10y yield up 100 basis points (bps) ytd]. Our base case remains for a correction in one or both of these rates in the coming months. SARB will likely hike by 25 bps this month, taking the repo rate to a peak of 8,50% (with upside risks to this estimate should inflation surprise to the upside). The Fed is expected to hike twice more this year, which could push out the first rate cuts by both central banks to around the middle of 2024.
SA inflation expectations have risen recently, but falling long-run trend remains intact
SA’s BER inflation expectations survey showed a deterioration across the board in 2Q23, with average inflation expectations higher across all periods, apart from the five-year-ahead expectations, which fell 30 bps to 5,2%. Despite the recent increase, inflation expectations have maintained their long-run declining trend since 2013.
A correction in one or both of these markets is likely in the coming months
To return SA’s ex-ante real policy rate to relative attractiveness requires a lower US ex-ante real policy rate (probably by a lower OIS rate as the Fed communicates an end to its hiking cycle later this year and the market extrapolates this to price in cuts to the policy rate). Alternatively, FRA rates would need to rise to reflect a higher-for-longer approach by SARB, and inflation expectations should ease as headline inflation continues to decelerate.
Another SARB hike implies that upside for front-end bonds has compressed, in our view
SA’s bond yields moved lower for most of June, from what we would describe as a large oversold position during the second half of May (see A pessimistic reflection of current yields dated 15 May). The curve also bull steepened. However, now for the first time since early May, we would describe the front end of the nominal curve as broadly “fair”.