RAND
Rate hikes give investors more reason to buy into SA
April 24, 2007
By George Glynos
Against expectations at the start of the year, the rand appears to be far more resilient than anticipated. With the trade balance under significant pressure early in the year because of fuel-related product imports and logistical disruptions, many thought the rand would stay on the defensive.
Few anticipated the dramatic weakness in the US dollar over recent weeks and the turn of sentiment against it. The main driver of this sentiment appears to have been the interest rate outlook and growing confidence among investors that the US Federal Reserve will be forced to reduce rates towards the end of this year or the beginning of 2008.
The prospect of lower rates in the US has had a positive effect on the rand for two reasons. The first is the gains they have induced on US equity markets, which have helped reduce global risk aversion.
The second and more obvious reason is the widening of the gap between South African and US interest rates. In simple terms, this is yet another example of how higher interest rates could benefit rather than impede the rand.
Some schools of thought suggested that the higher interest rate environment would limit the growth outlook and the JSE's ability to attract foreign inflows. However, growth has held up well.
Growth in manufacturing production and exports are slowly picking up the slack left by softening consumer demand, lending resilience to the domestic economy.
Strong performances in the productive sectors have led to a higher quality of growth. Gross domestic product growth of 4.5 percent and up now looks easily achievable.
Furthermore, the Reserve Bank's efforts to engineer a soft landing in the local economy and find alternative ways of restricting consumption on credit, apart from raising interest rates, have gone a long way in assuring investors that the members of the monetary policy committee are indeed sensitive to growth.
This, coupled with the improved performance of offshore markets, has lifted the JSE to fresh record levels despite expectations that growth in 2007 could moderate.
It also puts to rest any fears of rand weakness caused by a massive exodus of funds from local equities.
It is therefore not surprising to find foreigners less averse to investing in the local bond market, especially in the shorter-dated bonds whose yields are proportionately more attractive. The R153 yield continues to offer a premium of nearly 3.5 percent above the equivalent US bond, while the 10-year R203 offers a premium of nearly 3 percent.
According to Bond Exchange of SA stats, inflows into the bond market this month have totalled R4.1 billion compared with just R1.2 billion into the JSE.
Since the beginning of March, the inflows are amplified further, with foreign investment into the bond market totalling R12.8 billion against JSE inflows of just R2.6 billion.
It is therefore clear what the likely driver of rand resilience will be in the months ahead. If interest rates at current levels are attracting such impressive inflows, rates at even higher levels might have given the rand a significant boost.
Such rand strength may be considered undesirable if it helps reignite structural imbalances, explaining why the Reserve Bank would want to hold off lifting interest rates.
The concern, however, is that worsening inflation will leave it with no choice but to lift rates - and risk fuelling another bout of rand strength.
George Glynos is the managing director of Econometrix Treasury Management
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