JOHANNESBURG – In normal times a very weak economy would have required economic stimulus measures such as low lending rates.
But as we all know by now, we are effectively in an economic paralysis situation where the medicine has to be taken to create a healthy economic environment to attract and retain new investment locally and from abroad.
Whether we like it or not, the cost of borrowing both locally and abroad by governments is heavily influenced by the credit ratings assigned to them by agencies such as Fitch, S&P Ratings and Moody’s. The credit ratings are based on various factors such as political and economic stability and most are forward-looking.
It is reasonable to expect that the market wants to be compensated for additional risk and it is best illustrated by the countries’ 10-year government bond index yield spreads to US treasuries compared to their corresponding credit ratings where the US is seen as low risk.
It is therefore no coincidence that there is a linear relationship between the BRICS member countries’ yield spreads to US treasuries and their credit ratings. It is evident that South African 10-year government bond yield spread to US treasuries is currently smack-bang on the trend line and, therefore, correctly priced compared to the other BRICS bond markets given their respective credit ratings.
It is also important to note that there are times when a country's bond yield spread to US treasuries gets out of line with the country's credit rating as the bond market may differ from the credit agencies in regard to that country's credit rating. Sometimes the market is correct in the anticipation of a change in credit ratings while at other times it creates opportunities.
The UK and Italian bond markets are current examples of bond markets moving out of line of the Eurozone yield spread to US treasuries curve compared to credit ratings.
This is most probably because the markets are anticipating a cut in the UK’s rating as a result of Brexit while Italy’s collision-course with the EU is likely to lead to cuts in the country’s credit ratings.
Another important factor influencing the countries’ yield spreads to US treasuries is obviously the yield on US treasuries itself.
The BRICS yield curve per corresponding credit ratings in November is 100 basis points lower than in June last year and is mainly attributable to a rise of nearly 100 basis points in the US 10-year government bond yield.
While South Africa's bonds are correctly reflecting the country's credit ratings the main risk factor to our bond market is a further de-rating. The major risk for a de-rating is that our inflation rate is out of line with other countries and especially the other BRICS economies, given their corresponding credit ratings.
It is critical for the country to get the inflation rate closer to 4.5 percent from nearly 5 percent as soon as possible to avoid further de-ratings by the credit agencies. This is perhaps the overwhelming reason why the Monetary Policy Committee is likely to hike the repo rate – the rate at which the Reserve Bank lends money to commercial banks – today.
South Africa’s 10-year government bond index’s yield to maturity is a very good leading indicator of where lending rates are heading and is currently trading at around 9.5 percent.
The gap between the 10-year government bond yield and the repo rate has widened and is indicating that the repo rate could be hiked by 0.25 percent.
The recent fall in the oil price may have saved us from a larger hike.
Yes, it is a bitter pill to swallow but economic stability and certainty are the cornerstones of our country's new spring.
Ryk de Klerk is an independent analyst. Contact [email protected] His views expressed above are his own. You should consult your broker and/or investment adviser for advice.