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African bonds markets are vulnerable to the deterioration in global risk appetite

May 11, 2022by Nicholas Kabaso
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Local Market Commentary

  • News flow in Zambia remains centred around the mining sector at present. Yesterday, the President’s office said that while Vedanta remains a shareholder in Konkola Copper Mines (KCM), the end of litigation would not equate to handing the operation back to the company. President Hichilema was quoted as saying, “Vedanta and ourselves agreed that we suspend litigation, by-and-large as a partial way of resolving the matter. The outcome I wouldn’t predict, but there will be a resolution of Konkola Copper Mines.”
  • Meanwhile, Vedanta has written to the Zambian government indicating its willingness to invest $1bn in the mine seized from it under a previous government if given back control. According to a leaked letter seen by Reuters, Vedanta said that apart from investing in KCM, it would also implement several social responsibility programmes if it resumes control of the firm. Vedanta added that the prolonged dispute with the government was not benefiting any of KCM’s stakeholders and that it was necessary to reach a mutually beneficial solution swiftly.
  • While African bonds have been more resilient to the deterioration in global risk appetite than emerging market bonds, given that investors often buy and hold African bonds through to maturity due to thin liquidity in the secondary market, African bonds are still vulnerable to the global risk-off conditions. This is reflected by the year-to-date performance of the AFMI Bloomberg African Bond Index, which has lost just over 5% in 2022. This compares to losses of more than 16% in emerging market bonds.
  • The vulnerabilities of African fixed income markets to the worsening global conditions were highlighted in a report published by S&P on Tuesday. The global rating agency said that declining global growth on the back of the Russia-Ukraine conflict and a slowdown in China is weighing on the domestic debt-carrying capacity of frontier markets in Africa. S&P added that sizable nonresident positions in some local bond markets such as Egypt, Ghana, and South Africa, boost liquidity, but often at the expense of increased sensitivity to current shifts in global monetary policy.
  • S&P noted in its report that many African sovereigns enter this challenging post-pandemic period with high existing domestic debt stocks and large refinancing requirements. Country’s with more fragile debt and macroeconomic fundamentals are the most exposed to the deterioration in lending conditions amid the persistent risk-off conditions and hawkish pivot from central banks across the world.
  • Base metals continued to struggle yesterday as the world priced for lower demand amid the COVID-19 induced lockdowns in China and a more aggressive Fed which has the potential to curtail economic dynamism in the US.
  • This morning we have the price of copper and aluminium up in the Asian session as short term specs bet on a softer inflation number which would filter through to rate hike expectations. Analysts are expecting a sharp pull back in the April reading of inflation, the expectation is that inflation cools to 0.2% in April from 1.2% in March month on month.
  • Moving over to the US, the key economic release today will be the CPI print for April. Given the decisively hawkish policy plan outlined by the Fed at its May policy meeting, and uncertainty over whether such an aggressive tightening cycle is possible, investors will be analysing US CPI numbers carefully for fresh clues into prospective monetary policy. In particular, they will be assessing whether the March CPI print of 8.5% y/y was the high-water mark of this inflationary episode, or whether further upside potential still exists. Consensus expectations as per Bloomberg surveys support the former, with a slight decline of the inflation rate to 8.1% y/y being pencilled in. Note that even if that is the case, US inflation will not reach the Fed’s 2% target anytime soon, with a rate closer to 6% expected by year-end. Fed Chairman Powell and Co. will thus still feel inclined to hike interest rates aggressively in the coming months, unless the decline from multi-decade high inflation proves to be faster than what is currently expected.
  • Ahead of the inflation data later today, the USD remains consolidative. The inflation figures will be key as they will offer insight into the conviction with which the Fed will need to act to regain control of inflation. The global economy is slowing, with some important jurisdictions forecasting recessions. The U.K. and the E.U. will both experience tough conditions through H2, and it is against this backdrop and the effects of rapidly tightening monetary policy that investors would do well to reconsider their expectations for Fed tightening. The Fed may indeed struggle to tighten monetary policy to the extent that they have indicated. Consolidative behaviour remains the order of the day against the majors this morning, with no material change to week-long ranges.


Rand and International FX Commentary

  • Two failed attempts to crack higher suggest that the market be fully priced. The main reason for the consolidated behaviour and the reluctance to take on a distinct direction revolves around the upcoming US inflation data scheduled for release this afternoon. The data is market-moving and will offer investors fresh perspectives on one of the key drivers of central bank policymaking at the moment.
  • The war in Ukraine, lockdowns in China, high commodity prices, and logistical supply chain issues have formed the perfect storm, especially in countries that have experienced high growth in money supply. The pressures are mostly supply-side, implying that curtailing demand on a local/regional/country-specific level will not help. The only way to curtail such inflation is a coordinated effort across multiple jurisdictions to slow global growth, a theme that has unfolded in recent months and will continue to unfold throughout the remainder of the year.
  • It becomes progressively trickier to gauge inflation when the root cause rests outside the country in which policy is conducted. This implies forecasts can often be wrong in such instances, leaving the door open for market volatility to unfold. This is a key reason why markets and investors will trade cautiously ahead of the data and adopt a clearer direction once the data release is behind them. Today, the market expects an inflation reading of 8.1%, while the skew of expectations still has the risk skewed mildly to the topside.
  • At 16.0800, the ZAR is no longer the obvious sell it might’ve been at 14.50. Its overvaluation has switched back to undervaluation. The SARB is looking to hike further. The ZAR Sentiment indicator has remained in positive territory, and terms of trade remain supportive of ZAR resilience. In other words, many could argue that the adjustment of R1.50/dlr is sufficient to remove some of the speculative elements behind the movement in the ZAR. All that to say that a higher than expected US inflation reading may boost the USD again and help it gain ground against the ZAR, but those gains will be difficult to sustain.

Nicholas Kabaso

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