More rand and bond woes ahead for SA as Fed tapering draws nearer
By now we've all heard about the Federal Reserve's imminent tapering – the Fed's plan to cut back sharply on its programme of quantitative easing. And we all know that it is expected to have some pretty serious consequences for companies and economies around the world. In this interview, Peter Brooke, Boutique Head of Old Mutual Investment Group MacroSolutions, outlines just what those consequences are likely to look like for South Africa. Brooke's most important point is that South Africa is highly reliant on portfolio flows to fund its current account deficit, and so when overall liquidity in the global market declines, South Africa is going to feel the bite. The rand will probably depreciate further, putting strain on a lot of industries, and South African bond yields will rise as prices fall, hurting fixed income investors. On the plus side, we all know that tapering is coming, and investors have plenty of time to prepare. – FD
GUGULETHU MFUPHI: Several of the Fed's own financial tests for reducing its asset purchases look to have been met and it increasingly appears that tapering is coming at the Fed's next meeting, due to take place next week. Peter Brooke, Boutique Head from Old Mutual Investment Group MacroSolutions joins us now. Peter, tapering, tapering, and tapering…it's always been on the cards. Questions have been raised as to when it will kick in and judging by many economists' estimations, they expect during the next Fed's meeting due to take place next week. Is this realistic?
PETER BROOKE: I think the exact timing is going to be tricky. There's still a fairly big consensus/thinking that it's out in March. The bottom line is, for us it's not a case of 'when' and it's not a case of timing. It's the fact that it is happening, that liquidity will incrementally be taken away from the market, and the impact that that has on South Africa and particularly in our fixed income market and, at the end of the day, what impact that has on our customers.
GUGULETHU MFUPHI: So let's touch on the impact: what impact could we potentially see on the local markets?
PETER BROOKE: Well, we've already seen a fair amount of that impact. First off, is the rand: South Africa is a loser in a lower liquidity environment. We rely on the kindness of strangers to fund our current account deficit. In terms of capital flows, particularly on the fixed income and equity side or the portfolio flows, so we've seen that the first impact is a weaker rand. However, we've also seen another impact, which is obviously that global rates have risen. This means that our bond yields have risen. In fact, if you look over the last 12 months, fixed income as in inflationary bonds and nominal bonds are both down over the last 12 months, so you've actually not made any money in that space.
GUGULETHU MFUPHI: I take it that the long-term outlook isn't very positive.
PETER BROOKE: Well you see, this is the conundrum that the man on the street faces. They're sitting in cash and cash is giving you a little bit less than five percent. Now inflation is 5.3 percent, so you're going backwards in real terms. Everyone has heard about the tapering, the great rotation, or this big secular shift and they're saying 'well therefore, we can't go into fixed income'. Certainly, for the last year it hasn't been great to be in fixed income. However, what's important is that you still have to move out of cash because we can't really see cash yields in South Africa going up, so you continue to go backwards in real terms. As markets re-price you will get increasing opportunities in the fixed income space, whereby you can better yield. Let me give you some examples. Just, very simply, the long bond in South Africa is sitting at eight percent, longer dated bonds are greater than that, and Transnet issued a bond overseas at 9.5 percent. That's 4.5 percent above where cash is and that starts to become attractive.
ALEC HOGG: Peter, why did Transnet go abroad, given the fragility of the South African rand and the premium that you've just indicated that they actually paid, over what they could have raised the money at locally?
PETER BROOKE: Well interestingly, in terms of the rand, they issued a rand bond, so there's no currency risk. They pay their coupon and their repayment back in rand. They just issued it overseas. I think it's a slightly unusual move. It's really sort of pushing out the barriers into new funders as opposed to tapping the local funding market. The local funding market, I think, has been reluctant to pay up for long dated bonds because they're concerned about this tapering impact and the bond was a seven-year bond, which is fairly long dated. I'll get that premium, and that's the big issue: it changed the price point. It starts to become interesting.
ALEC HOGG: it does indeed. So, getting back to that great rotation issue that you mentioned a moment ago, when is it going to be the right time to get out of equities and switch across to bonds? What are the signals that we must look for?
PETER BROOKE: If you look at the long-term equities versus bonds, what we're seeing is actually the first turn, and this is going to be a secular trend. We would therefore prefer equity to bonds – globally – for a number of years to come. I think the situation in South Africa is much more nuanced because we actually still get a decent yield on our bonds in South Africa. We have higher interest rates and at the same time, the South African equity market is looking fairly expensive compared to its history and compared to global markets. I think the point I really want to raise, is investors are trapped in terms of this fear of bonds vis-à-vis cash, and particularly in the income fund space. If it makes sense to you, you have to remember that if you buy that Transnet bond and you hold it for seven years, the capital change doesn't make any difference. At the end of it you're making 9.5 percent. That will be better than what you're going to get in the bank, sitting in cash.
GUGULETHU MFUPHI: Thank you so much to Peter Brooke. He is the Boutique Head from Old Mutual Investment Group MacroSolutions.