Key points:
- This week’s inflation data may seem unrelated to the performance of the ZAR, but ETM analysis shows that it plays a significant role in determining longer-term trends. Aside from the parity pricing pressures that inflation exerts on a currency, the inflation environment will largely dictate the SARB’s monetary policy and the level of interest rates.
- It is not always just about the absolute level of interest rates, but the general direction of interest rates too. The best position to start from is where nominal interest rates are high relative to history, and SA’s peers and bond yields could decline over time to help investors extract capital gains. In SA’s case, both seem to apply, although much will depend on the fiscal framework that National Treasury eventually implements and inflation remaining subdued.
- Of those two focal points, this report deals with the inflation outlook, given this week’s consumer and producer inflation readings. Both data surprised to the downside and, and in the process, helped bond yields decline. The stage is set for the bond market to rally, especially if the fiscal authorities can assist by dialling fiscal risk down.
Baseline view:
As long as fiscal risk does not rear its ugly head, the monetary environment broadly supports a virtuous cycle. This scenario is plagued by risks including but not limited to SA’s structural deficiencies, persistent above-inflation administered price increases and President Trump’s tariffs. However, the monetary environment is conservative enough to warrant some rate cuts, and that should attract some flows back into SA bonds through the carry trade that ultimately should help the ZAR stage a recovery back towards the 18.00/dlr handle or below.
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