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FOMC meeting minutes more hawkish than some had expected

January 6, 2022by Nicholas Kabaso
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Local Market Commentary

  • Growth dynamics are back in focus today. Regional PMI was mixed with three of the African PMI scores tracked by ETM coming in higher than the previous month, while three decreased. The moves to the downside were more pronounced than those to the upside and as such, the Sub-Saharan Africa average PMI reading edged lower, falling from 52.8 in November to 52.5 in December.
  • Despite nudging lower, Zambia’s headline PMI reading remained buoyed in positive territory. For context, Zambia’s economy-wide PMI reading came in at 51.5 in December, down from 51.8 in the previous month. Markit said in the report that the main takeout was a further expansion in new orders, while the rate of growth in new business quickened for the fourth successive month and was the strongest reading in more than 3 years. In response to higher new orders, companies expanded both their staffing levels and purchasing activity in December. The rise in employment was the seventh in as many months, while input buying increased for the third month running.
  • Looking ahead, business confidence improved, with around 40% of respondents predicting a rise in activity over the course of 2022. Optimism generally reflected hops of ongoing improvements in demand. That said, respondents highlighted the uncertain nature of conditions at present.
  • Given its influence on the global fixed income market, it is worth zooming in on US Treasuries this morning. The hawkish FOMC meeting minutes published last night saw US Treasury yields rise further as the market prices for a more aggressive policy tightening by the Federal Reserve this year as inflation pressures persist.
  • The minutes from the December Fed meeting confirmed that policymakers discussed hiking interest rates earlier and at a potentially faster pace than previously communicated, given the strengthening economy and higher inflation. The details of the meeting also showed that some officials now favour qualitative tightening soon after the first rate hikes, with all members unanimous in their view that these hikes will come this year.
  • Yields on the 2yr and 10yr Treasuries rose above 0.83% and 1.70%, respectively, while the S&P had its worst session since 26 November, sliding by around 1.50%. Market pricing for a rate hike as early as March has now reached 80%. The sustained rise in US Treasury yields has come as a headwind for emerging and frontier market bonds. Going forward, given our expectations for inflation to remain elevated in the first half of the year, we expect the broader bearish bias in global bonds to persist.

Rand and International FX Commentary

  • Yesterday was a good day for the ZAR. It is difficult to attribute it to one, single thing. The USD had depreciated slightly on a trade-weighted basis, and that contributed. More Zondo commission findings were highlighted in the press, which further helps to unearth the depth of corruption within the governing party and the SOEs, and finally, SA seems to be exiting its 4th wave at a time when most other countries are deep in the middle of theirs.
  • The ZAR’s undervaluation and its position high up the carry attractiveness rankings mean that it also has the ability to attract foreign capital. All of this needs to be contrasted against the Fed’s desire to normalise monetary policy. On the one hand, the USD will enjoy monetary policy divergence from its major trading partners. On the other, emergence from the pandemic also means that overall risk appetite is likely to increase, detracting from the USD’s appeal. As it is, the USD is comfortably overvalued, with much of the policy divergence is already priced in.
  • This might help explain the somewhat schizophrenic behaviour of the ZAR in the past two months. This morning, investors will also need to deal with the outcome of the latest Fed minutes, which helped the USD recover yesterday. Not only did the minutes allude to a taper, but they also pointed to the possibility of dialling back bond holdings or shrinking the Fed’s balance sheet. Central to the discussions at the Fed was the high degree of inflation and the need to reduce it on a more sustainable basis to ensure that inflation expectations are not dislodged.
  • The timing of balance sheet moderation is unclear, but it would make sense that it could start after the Fed has announced its first rate hike. That would generate a double whammy to asset prices that have greatly supported the ultra-loose monetary policy. Shrinking the balance sheet would likely take much the same shape as it did previously. As bonds mature, the central bank would not roll them over, they would be redeemed, and the balance sheet would shrink.
  • Interestingly, the USD did not follow through with its rally, implying that the pressure on the ZAR to depreciate would also ease. This week remains tricky in picking a direction, and the safest place would be the safety of the sidelines until the dust settles and trading volumes return to more normal levels.

Nicholas Kabaso

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