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Fed Calming Market as Foreign Buyers Return: South Africa Credit
Foreigners bought a net 8.68 billion rand ($878 million) of South African debt last month following outflows of 11.1 billion rand in May and June, the most over two months since September 2011, according to Johannesburg Stock Exchange data. South African 10-year bond yields rose 21 basis points in July, compared with an increase of 23 in Hungary and 44 in Turkey.
Emerging-market bond rates have surged since May 22, when Fed Chairman Ben S. Bernanke signaled that policy makers may begin tapering U.S. asset purchases that helped spur demand for higher-yielding debt. While U.S. gross domestic product growth beat forecasts in the second quarter, the Fed said two days ago it will maintain its $85 billion of monthly quantitative easing. South Africa’s central bank has left its benchmark rate at a three-decade low for more than a year after growth slumped.
“There is still some uncertainty as to what the Fed will do, but even if they start to taper it won’t be a significant move away from their accommodative policy,” Sean McCalgan, head of real-time research at ETM Analytics in Johannesburg, said by phone yesterday. “The market may have overpriced its expectations. That is important for the local bond market.”
The rand gained 2.2 percent against the dollar in the two months to end-July, damping concern about the effect on inflation after a 16 percent slump in the previous five months. Reserve Bank Governor Gill Marcus has said that currency weakness is a major threat to price growth. The rand slipped 0.5 percent to 10.0213 per dollar as of 11:06 a.m. in Johannesburg today. The yield on rand bonds due December 2026 climbed eight basis points, or 0.08 percentage point, to 8.26 percent.
Inflation unexpectedly slowed to 5.5 percent in June from 5.6 percent a month earlier, remaining below the 6 percent upper limit of the central bank’s target range. Analysts predicted an increase, according to a Bloomberg survey. The first quarter current-account gap shrank to 5.8 percent of gross domestic product, from 6.5 percent, according to the Reserve Bank. The trade deficit shrank for a second month in June, to 7.7 billion rand, the Revenue Service said on July 31.
Demand in Africa’s biggest economy is weak as consumer spending remains under pressure, according to the central bank. Policy makers last week lowered their economic growth forecast for this year to 2 percent, while unemployment increased to 25.6 percent in the second quarter, the highest jobless rate in two years.
“The Reserve Bank forecasts a slowdown in growth,” while it “expects any breach of the inflation target to be temporary,” Kamilla Kaplan, a Johannesburg-based economist at Investec Ltd., said in an e-mail on July 31. “Monetary policy is likely to remain accommodative with interest rates remaining on hold until the end of 2014.”
Inflows into the nation’s bond market may be short-lived, given the relatively large current-account deficit, according to Guillaume Salomon, an emerging-market strategist at Societe Generale SA.
The current-account and fiscal deficits, together with a low growth rate and accommodative monetary policy, leave South Africa vulnerable to external shocks. The nation needs average inflows of 16 billion rand a month to finance the shortfall on its current account, according to Standard Bank Group Ltd. The budget gap for the fiscal year that ended in March is estimated at 5.1 percent, according to the National Treasury.
“We are in a transition phase where the Fed is going to be gradually removing some of the extreme liquidity we have seen,” Salomon said by phone from London yesterday. “Whether it is in September, whether it is further down the road, the market will have to gauge that. Eventually it is going to make it quite challenging for markets that require bond inflows to finance their current-account deficits.”
Credit default swaps for South Africa, contracts insuring the nation’s debt against non-payment, dropped 42 basis points since reaching a four-year high in June to 222 yesterday. The extra yield investors demand to hold South Africa’s dollar debt rather than U.S. Treasuries dropped seven basis points to 266.
Foreign demand for rand bonds is set to continue in coming months even as the fiscal deficit and rising inflation puts pressure on yields, McCalgan at ETM said.
“A lot of it will be reliant on offshore policy expectations,” he said. “We will probably see inflows carry on in months ahead, presuming there is no shock in that respect.”
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