Markets see further hikes as financial crisis shifts

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Financial markets, which proved more accurate predictors of the repo rate’s path than economists last week, are pointing to a string of further rate hikes.

Absa Capital analyst Mike Keenan said on Friday that forward rate agreements (FRAs) were “fully discounting a 50 basis point hike for March, another 50 in May, a further 50 in July and almost another 50 by September”. FRAs are contracts that run for three months in a row, starting at some point in the future. Bond markets are also anticipating further rate rises.

A cumulative increase on this scale would push the repo rate to 7.5 percent before the end of the year and benchmark prime and mortgage rates to 11 percent – a level last seen in mid-2009.

Heavily indebted consumers would be under increasing financial pressure, reducing their scope to spend and the economy’s ability to grow.

The market’s reaction comes after Reserve Bank governor Gill Marcus surprised economists by raising the key repo rate by 50 basis points last week to 5.5 percent. Economists had assumed that South Africa’s low growth prospects would postpone a rate hike, despite the plunging rand.

This country is not alone in its problems – emerging markets are in disarray. South Africa, Turkey, Brazil, India and Indonesia – known as the fragile five – were outdone last week by Argentina when its currency fell 11 percent in one day.

South Africa is in pain. Citi figures show that in the month to Thursday, foreigners sold a net R28.8 billion worth of local bonds and JSE-listed shares. This follows inflows of little over R1bn last year. The country depends on savings from abroad to fund the deficit on the current account – the gap between earnings from exports of goods and services and the import bill.

Marcus said last week that this phase of the crisis (which started in 2008) was creating “new challenges for emerging market economies”. She took over the helm of the Reserve Bank in November 2009 when the world was reeling from the financial upheavals that started with the collapse of the US low-income housing bubble in 2007/08. She has warned often of the duration, the severity and the implications of the unfolding disaster.

In April 2013, she said the subprime crisis was mutating “between a growth crisis, a fiscal crisis, a sovereign debt crisis, a systemic banking crisis and a political crisis”. And she noted that the resolution of one crisis created problems in another sphere.

This is precisely the case now. After more than five years of pumping money into the US – therefore global – economies, the US Federal Reserve has changed tack. US gross domestic product (GDP) rose 3.2 percent between October and December last year, compared with the previous three months. Stanlib economist Kevin Lings notes this GDP estimate “represents an initial assessment of US economic activity”.

However, the figures are in line with expectations and the apparently sustained recovery has prompted the Federal Reserve to cut back on its easy money programme. Last month it reduced by $10bn (R111bn) its $85bn monthly quantitative easing and this month it will reduce by a further $10bn.

Emerging markets, which had been the recipients of large flows, are now seeing them recede and growth prospects diminish as the cheap money dries up.

Frontier Advisory’s Martyn Davies describes the short-term outlook for emerging markets as negative – “China aside”. And he notes that the countries that can differentiate themselves through “pragmatic structural reform” are best placed to escape the general malaise.


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