Global Investing

Risks loom for South Africa’s bond rally

Investors are wondering how much longer the rally in South Africa’s local bond markets will last.

The market has received inflows of over $7.5 billion year-to-date, having benefited hugely from Citi’s April announcement that it would include South Africa in its elite World Government Bond Index (WGBI).  But like many other emerging markets, South Africa has also gained from international investors’ hunger for higher-yielding bonds. And the central bank’s surprise rate cut last week was the icing on the cake, sending 5-year yields plunging another 30 basis points.

There are some headwinds however. First positioning. Around a third of government bonds are already estimated to be in foreigners’ hands. Second, markets may be pricing in too much policy easing (Forward rate agreements are assigning a 77  percent probability of another 50 bps rate cut within the next six months).  That’s especially so given local wheat and maize prices have been hitting record highs in recent weeks.

For these reasons, UBS analysts say it is time to book profits.  They note that the 2026 bond they recommended buying on June 15 has already rallied more than 100 bps.  Analysts at the bank write:

We did not anticipate the global grab for duration to be as intense as it has been. Yields have come in a lot and we think it is now time to get out of this trade.

South Africa’s joins the rate cutting spree

Another central bank has caved in and cut interest rates — South Africa lowered its key rate to a record low of 5 percent at Thursday’s meeting. In doing so, the central bank noted growth was slowing further. ”Negative spillover effects (from the global economy)  likely to intensify,” it said.

Very few analysts had predicted this outcome, reckoning the central bank (or SARB as it’s known) would hold fire until its next meeting due to concerns over the currency and inflation.  But in fact, forward markets had guessed a cut was coming, especially after June inflation was lower than expected. And after all, even the conservative Bank of Korea cut rates last week to buck up domestic growth and compensate for slumping exports.  There have also been some policy easing in Taiwan and Philippines in the past week while earlier on Thursday, Turkey’s central bank unleashed more liquidity into the banking system. Kevin Lings, chief economist at Stanlib in Johannesburg says:

(South Africa’s rate cut) would suggest that the Reserve Bank feels they are a little bit behind the curve when they look at interest rate movements in other countries and hence the decision.

Doves to rule the roost in emerging markets

Interest rate meetings are coming up this week in Turkey,  South Africa and Mexico.  Most analysts expect no change to interest rates in any of the three countries.  But chances are, the worsening global growth picture will force policymakers to soften their tone from previous months; indeed forwards markets are actually pricing an 18-20 basis-point interest rate cut in South Africa.

Doves in South Africa will have been encouraged by today’s lower-than-expected inflation print, coming soon after data showing a growth deceleration in the second quarter of the year. Investors have flooded the bond markets, betting on rate cuts in coming months. In Turkey and Mexico, no policy change is priced but a few reckon the former, reliant on a policy of day-to-day tinkering with liquidity, may narrow the interest rate corridor in a nod to slowing growth.

For now, all three banks could be constrained from cutting rates by fear of currency volatility and the potential knock-on effect on inflation. Of South Africa, analysts at TD Securities write:

South African bond rush

It’s been a great year so far for South African bonds. But can it get better?

Ever since Citi announced on April 16 that South African government bonds would join its World Government Bond Index (WGBI),  almost 20 billion rand (over $2.5 billion ) in foreign cash has flooded to the local debt markets in Johannesburg, bringing year-to-date inflows to over 37 billion rand. Last year’s total was 48 billion. Michael Grobler, bond analyst at Johannesburg-based brokerage Afrifocus Securities predicts total 2012 inflows at over 60 billion rand, surpassing the previous 56 billion rand record set in 2o1o:

The assumption..is based on the fact that South Africa will have a much larger and diversified investor base following inclusion in the WGBI expanding beyond the EM debt asset class

Where will the FDI flow?

For years the four mighty BRIC nations have grabbed increasing shares of world investment flows. But the coming years may not be so kind.  These countries bring up the bottom of the Economic Freedom Index (EFI) for 2012. Compiled by Washington D.C.-based think-tank The Heritage Foundation the EFI measures 10 freedoms —  from property rights to entrepreneurship – and according to a note out today from RBS economists, there is a strong positive link between a country’s EFI score and the amount of FDI (foreign direct investment) it can secure. So the more “free” a country, the more FDI inflows it can expect to receive — that’s what an RBS analysis of 2002-2008 investment flows shows.

So back to the BRICs. Or BRICS if you add in South Africa (part of the political grouping though not yet included in the BRIC investment concept used by fund managers). The following graphic shows Russia languishing at the bottom of the EFI, China just above Russia and India third from bottom.  Brazil is sixth from bottom while South Africa ranks two places higher.

At the other end of the spectrum is tiny Singapore. Its EFI score is double that of Russia and between 2002-2008 it attracted FDI equivalent to 50 percent of its economy. Russia in contrast saw negative net FDI (outflows exceeded inflows)

BRICS: future aid superpowers?

Britain’s aid programme for India hit the headlines this year, when New Delhi, much to the fury of the Daily Mail, described Britain’s £200 million annual aid to it as peanuts. Whether it makes sense to send money to a fast-growing emerging power that spends billions of dollars on arms is up for debate but few know that India has been boosting its own aid programme for other poor nations.  A report released today by NGO Global Health Strategies Initiatives (GHSi) finds that India’s foreign assistance grew 10.8 percent annually between 2005 and 2010.

The actual sums flowing from India are,  to use its own phrase, peanuts. The country provided $680 million in 2010. Compare that to the $3.2 billion annual contribution even from crisis-hit Italy. The difference is that Indian donations have risen from $443 million in 2005, while Italy’s have fallen 10 percent in this period, GHSi found. Indian aid has grown in fact at a rate 10 times that of the United States. Add to that Indian pharma companies’ contribution – the source of 60- 80 percent of the vaccines procured by United Nations agencies.

Other members of the BRICS group of developing countries are also stepping up overseas assistance, with a special focus on healthcare, the report said. BRICS leaders meet this week to ink a deal on setting up a BRICS development bank.

from MacroScope:

Emerging markets: Soft patch or recession?

Could the dreaded R word come back to haunt the developing world? A study by Goldman Sachs shows how differently financial markets and surveys are assessing the possibility of a recession in emerging markets.
One part of the Goldman study comprising survey-based leading indicators saw the probability of recession as very low across central and eastern Europe, Middle East and Africa. These give a picture of where each economy currently stands in the cycle. This model found risks to be highest in Turkey and South Africa, with a 38-40 percent possibility of recession in these countries.
On the other hand, financial markets, which have sold off sharply over the past month, signalled a more pessimistic outcome. Goldman says these indicators forecast a 67 percent probability of recession in the Czech Republic and 58 percent in Israel, followed by Poland and Turkey. Unlike the survey, financial data were more positive on South Africa than the others, seeing a relatively low 32 percent recession risk.
Goldman analysts say the recession probabilities signalled by the survey-based indicator jell with its own forecasts of a soft patch followed by a broad sustained recovery for CEEMEA economies.
"The slowdown signalled by the financial indicators appears to go beyond the ‘soft patch’ that we are currently forecasting," Goldman says, adding: "The key question now is whether or not the market has gone too far in pricing in a more serious economic downturn."

Jean-Claude Trichet, EM c.bankers’ new friend

What a friend emerging central bankers have in Jean-Claude Trichet. Last month the ECB boss stopped euro bears in their tracks by unexpectedly signalling concern over inflation in the euro zone. Since then the euro has pushed steadily higher  — against the dollar of course, but also against emerging currencies. The bet now is that interest rates – and the yield on euro investments — will start rising some time this year, possibly as early as this summer.

That’s ptrichetrovided some relief to central banks in the developing world who have struggled for months to stem the relentless rise in their currencies.

Being short euro versus emerging currencies was a popular investment theme at the start of 2011, partly because of EM strength but also because of the euro zone debt crisis. “What that also means is that people who were short euro against emerging currencies had to get out of those positions really fast,” says Manik Narain, a strategist at investment bank UBS. Check out the Turkish lira — that’s fallen around 5 percent against the euro since Trichet’s Jan 13 comments and is at the highest in over a year. South Africa’s rand is down 6 percent too. Moves in other crosses have been less dramatic but the euro’s star is definitely in the ascendant. The short EM trade versus the euro  has more room to run, Narain reckons.

from Davos Notebook:

Will Goldman’s new BRICwork stand up?

RTXWLHHJim O'Neill, the Goldman Sachs economist who coined the term BRICs back in 2001, is adding four new countries to the elite club of emerging market economies. But does his new edifice have the same solid foundations?

In future, the BRIC economies of Brazil, Russia, China and India will be merged with those of Mexico, Indonesia, Turkey and South Korea under the banner “growth markets,” O'Neill told the Financial Times.

Hmmm.  Doesn't quite grab you like BRICs, does it? The Guardian helpfully offers an amended branding banner of  "Bric 'n Mitsk" (geddit?). But which ever way you cut it, it's hard to see a flood of investment conferences and funds floating off under the new moniker.

Brazil-style tax may not work for South Africa

Traders in South African securities woke to a nasty surprise this morning — media reports that the ruling ANC party is considering slapping a tax on “short-term” financial market flows, possibly similar to the 2 percent tax Brazil brought in last October.  Luckily for them,  it may not happen.

Like Brazil, South Africa is worried about the strength of its currency, the rand, which rose almost 30 percent last year against the dollar and has firmed a further 1.5 percent this year to trade near 7.25 per dollar. Analysts like Elisabeth Gruie at BNP Paribas reckon fair value would be around 9 per dollar.  South Africa, like Brazil, is a commodity exporter so needs a fairly valued currency. Hence the call for capital controls to keep out foreign speculative cash.

But the similarities stop there.

Investors may not have cheered the Brazilian tax but few have pulled their cash from the country, betting the returns on offer make the 2 percent levy worthwhile. But South Africa may have a harder time.  Its economy may grow this year by 3 percent compared to Brazil’s 7.6 percent. Johannesburg stocks, especially those of multinational precious metals firms are attractive but they are not cheap — they trade at 11.5 times forward earnings while Brazil’s are at 10.6 times. And the domestic consumption story is still weak in South Africa which makes its companies more vulnerable to the global growth picture.