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Spread between lower inflation and a fiscal bind
We estimate what to expect from spreads on the nominal curve if we are set for more dovish inflation surprises while the fiscal policy bind remains. This result is consistent with our research, which suggests that the back end of the curve remains largely irresponsive to any dovish monetary policy surprise. Fiscally induced inertia in ultra-long bonds is likely to keep the curve steep and, for the time being, we would continue to hold a bias for such an outcome should there be some bull curve flattening.
Lower inflation and a greater fiscal constraint
The recent developments on the inflation front, where the headline Consumer Price Index (CPI) surprised on the downside for July, have seen the Forward Rate Agreement (FRA) market pricing in a 25 basis points (bps) cut as soon as January next year. At the same time, fiscal data later this week is likely to suggest that pressure remains in place on both the revenue and expenditure sides.
What to expect from spreads if we see more dovish surprises
We estimate what to expect from spreads on the nominal yield curve if we are set for more dovish inflation surprises while the fiscal bind remains in place. We look at three factors, monetary policy, fiscal policy and the country’s external funding requirement, that together explains between 70% and 83% of the variation in the spreads.
Fiscal data for July suggests a substantial deficit
This week will see the release of July’s detailed monthly Budget data and would confirm a tighter fiscal bind, in our view. The July preliminary fiscal data, which we have already seen, reflects a monthly budget deficit of R123bn, well above the 10-year average deficit of R96bn for July. Our budget deficit forecast for the year is R340bn or 4,8% of GDP in 2023/24, rising to 5,2% in the outer years.
Core market views
- We believe cash appears attractive relative to the front and back ends of the nominal curve, with selective areas on the belly still providing value.
- The same goes for Inflation-linked bonds (ILBs), although we believe the curve should steepen somewhat and shorter maturities would provide better value in an environment where an external adverse inflation impulse remains likely.
- In general, we would be better buyers of longer-dated (Asset Swap) ASW spreads.
- Our fair value for the USDZAR is within the R16,50–17,00 range. With the rand at 19,00 against the USD, we believe the currency already reflects the “weak China trade”. At levels between 19,00 and 20,00, we are better buyers of the rand.
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