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Local Market Commentary
- Finance Minister Situmbeko Musokotwane yesterday said that a deal between the IMF and Zambia at the of June is unlikely, citing a slight delay. Musokotwane, however, indicated that Zambia will on Thursday virtually attend the meeting of its creditors’ committee in Paris, where the government will present its economic reform agenda and progress made since reaching a staff-level-agreement with the IMF in December. Musokotwane added that Zambia will also present a plan to achieve debt sustainability and the support it will require from creditors including initial assurance of debt treatment. Zambia needs financing assurances from official creditors to secure approval from the IMF board for a $1.4bn bailout package, and although the government is set to miss its end-of-June target, the talks are a step in the right direction.
- The base metal counters are all focused squarely on the Fed for today and what tighter monetary policy means for US economic growth. China although arguably the most important driver of base metal prices has for today taken a back seat.
- That said, we are seeing an element of support for the industrial metal complex coming from the improvement in Chinese industrial output which rose by 0.7% in May versus a decline of 2.9% in April.
- All eyes on are tonight’s FOMC rate decision. Heading into the meeting, markets are pricing in a 75bps rate hike as policymakers try to rein in rampant inflation. The professional market aggressively scaled up bets for an outsized rate hike after the May US CPI print beat expectations on Friday, coming in at a 40-year high of 8.6% y/y.
- The aggressive shift in rate hike expectations has triggered a fresh bout of selling pressure across bond and swap markets around the world as traders price in the risk of higher interest rates and the adverse impact of higher lending costs on the fiscal position of countries. In addition, bets for a more hawkish Fed have fueled risk-off conditions. US Treasury yields have spiked in June, with yields across the curve reaching fresh multi-year highs.
- Emerging and frontier market bonds have also sold off sharply this month. The JP Morgan EMBI Global Total Return Index, which we use as a proxy for the performance of emerging market bonds, has lost 3.09% over the past three sessions as bond yields surged. African bonds have not been spared, with the Bloomberg African Bond Index shedding 3.24% over the same period. On a year-to-date basis, emerging market bonds have lost more than 18%, while African bonds are down by almost 6%.
- While the headwinds for bond markets the world over are expected to persist in the near term as central banks and investors continue to underestimate how strong and persistent inflation is, we see a light at the end of the tunnel for bond markets. After ramping up bets on steeper Fed hikes, traders are now turning to when the policymakers in the US will need to cut interest rates as recession fears mount. While money markets are pricing in two subsequent 75bps rate hikes for June and July and more rate hikes in the coming months, traders are also now pricing in three 25bps rate cuts within two years. There is a strong probability that the Fed over-tightens as it looks to get a hold on inflation and then has to unwind rates late next year as growth risk continues to rise. The market is pricing in one 25bps cut for late 2023, followed by a further 50bps worth of rate cuts by the middle of 2024.
- This presents a great buying opportunity for bond traders in the months ahead. Traders can take advantage of the attractive valuations on offer before the tide turns and the market focuses on recession risks. Moreover, we expect global supply chain pressures to ease next year, which should help ease inflation pressures. This comes against the backdrop of high base effects, underpinning the notion that rate cuts are very likely in 2023.
- For now though, we expect the broad-based sell-off in bonds to continue as the Fed continues its fight against persistent inflation. That said, the risk heading into tonight’s FOMC meeting is, given the current aggressive market pricing, that the Fed is deemed not hawkish enough. This would likely result in a correction in bond yields and the USD.
Rand and International FX Commentary
- Today will bring with it the first and most important of this week’s three major central bank updates. Following a significant hawkish shift in pricing after Friday’s US CPI shock, the market is now positioned for a 75bp rate hike today. So much so, that anything less than that risks a strong recovery for US Treasuries and a severe backlash for the USD.
- Note that Fed officials haven’t been able to guide the market after Friday’s CPI data, as they have gone into a customary self-imposed silence ahead of the policy meeting. This has left the market in a confused and uncertain state, which led it to price in an extremely aggressive monetary tightening trajectory this week.
- Against this backdrop, the ZAR has maintained some composure and is once again trading back below the R16.0000/$ handle this morning. Whether it can sustain this resilience ahead of the Fed update, however, remains to be seen, as intraday volatility has been very high in recent sessions given uncertainty over what the Fed will decide.
- So much depends on the Fed’s policy update this evening, which will ultimately determine the USD-ZAR’s direction into next week and, perhaps, through the rest of the month. The pair is facing plenty of two-way risk, which makes for some particularly uncomfortable trade in a holiday-disrupted week that is already suffering from a dip in liquidity.