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African bonds sell off as central banks turn hawkish

May 30, 2022by Nicholas Kabaso
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Local Market Commentary

  • News flow was centered around the mining sector on Friday, with the Mines Ministry announcing the suspension of operation at three Chinese-run mines. The suspension of operations at the three mines comes after inspections revealed breaches. Operations at Jifumpa Mine, Collum Coal Mine, and Chibuluma Mine have been suspended until all the anomalies have been satisfactorily addressed, rectified and re-inspected.
  • In the base metals complex, Iron ore has risen swiftly in Asia with the metal gaining on hopes that the easing of COVID-19 curbs in China will boost demand as the economy reopens. Beijing has relaxed curbs with only 12 new cases reported, while Shanghai has been given the go ahead to restart all manufacturing from Wednesday.
  • Bloomberg reported – There was another positive sign from the steelmaking hub of Tangshan, where data showed blast-furnace usage rising in the week to May 27. Utilization rates are on course for a third monthly increase with operations holding steady despite lockdowns, drawing down on iron ore stockpiles. Copper also rose, extending the metal’s recovery from a seven-month low earlier in May.
  • African central banks have turned decisively more hawkish in recent weeks amid signs that inflation pressures across the continent are intensifying. Over the past couple of days, we have seen policymakers in South Africa, Ghana, Egypt and yesterday, Nigeria deliver bold rate hikes aimed at reining in inflation and restoring stability across their respective currency markets.
  • For context, the South African Reserve Bank raised its benchmark repo rate by 50bps at its May meeting, while central banks in Ghana, Egypt and Nigeria hiked their policy rates by 200bps, 100bps and 150bps, respectively. Nigeria’s rate hike came as a surprise to many with the central bank saying in recent commentary that it would leave rates on hold until the economy rebounded.
  • The shift in monetary policy in Africa comes as the US Federal Reserve and European Central Bank adopt increasingly hawkish stances that have reduced the appeal of African assets to offshore investors. This has been one of the main factors driving capital outflows and currency weakness across the continent this year. Although growth in Africa remains fragile, central banks are having to tighten policy to fight against soaring inflation.
  • While the hawkish pivot from African central banks will help provide some stability for currency markets, it has come as a headwind for bonds as traders price in higher interest rates. The hawkish pivot in regional monetary policy comes against the backdrop of rising rates across developed markets and dampened global risk appetite, all of which are weighing on the outlook for African bonds. Since the start of the year, the Standard Bank Africa ex SA Bond Yield Index has risen by more than 350bps to reach levels near the peaks seen during March 2020. Risks in the near term remain skewed to the upside. However, we do expect to see a notable correction towards the back end of this year or in early 2023.
  • In the FX market, the Kwacha is expected to be stable in the near-term on the back of continued central bank support and positive sentiment. While talks regarding debt restructuring are ongoing, it remains to be seen whether the ambitious timelines set by the government will be met. Delays in the process could prevent the Kwacha from meaningfully appreciating in the months to come.

 

Rand and International FX Commentary

  • The USD lost ground last week and remains on the defensive at the start of this week. As investors eased bets that the Fed would hike rates aggressively, so the USD lost some of its attraction, leaving most currencies to regain some lost ground. For context, the USD is overvalued against most currencies, and by quite some margin. The USD is at least 25% overvalued on a trade-weighted basis when considering data spanning the past forty years. Even if a modest correction of 5-10% on the USD were to unfold, that could shave at least R1.00/dlr off the USD-ZAR rate, highlighting the potential for the ZAR to appreciate USD weakness rather than anything SA related.
  • However, on the local front, the week ahead is likely to attract the attention of foreign investors, but for all the wrong reasons. In the last quarter of 2021, the unemployment rate rose to 35.3% on the narrow definition. Using the more realistic, broader definition, the unemployment rate is in the mid-40s. This week, the Q1 2022 data will be released. Many hope that it will reflect an improvement from the Q4 2021 data, but the risk is that the improvement will be sluggish as the economy struggles to recover amid load shedding, inflation, rising interest rates and many structural constraints.
  • It is not difficult to argue for ZAR depreciation. SA’s economy faces so many challenges that it seems logical to expect it, yet the ZAR’s performance in recent years says otherwise. Again, investors are reminded of the USD’s overvaluation, which forms the backdrop against which all the other challenges will detract from SA’s ability to grow. A weak economy translates into a trade and current account surplus as both consumption and investment in SA’s future are scaled back. Add to that SA’s carry attractiveness and its exposure to commodities that might perform well in a weaker USD environment, and one can appreciate that the outlook for the ZAR is much more nuanced than simply focusing on all the bad economic developments that are unfolding.
  • Beyond the unemployment data, investors will also gain insight into the latest money supply data and the state of the credit cycle, the trade balance, government finances, the Barclays manufacturing PMI, the all-economy PMI, and finally, the latest vehicle sales. In other words, this week will offer a comprehensive perspective of the state of the SA economy, which could have implications for how foreign investors perceive the risks associated with SA and whether anticipating an aggressive SARB is justified or even likely. For now, the USD-ZAR is trading at a critical level. A sustained break below 15.4000 opens the door for a much deeper retreat. Failure to do so, and any bounce, raises the probability that the right-hand shoulder of a head and shoulders formation could build to take the pair back towards the 16.00 handle. Therefore, this is an important week from a technical perspective.

 

Nicholas Kabaso

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