Morning Brief – Thursday 18th

The Evening Standard yesterday ran with an editorial wedged between the questionable and the totally unreadable – usually about page 8 for those unfamiliar with the free London newspaper edited by former Chancellor George Osborne. They attempted to depict the future dichotomy that their inevitable Prime Minister, Boris Johnson, will face: between a swift US deal and no US deal. Pander to Trump and he’ll notice blood in the water, distance himself from exercising the “special relationship” choosing instead to wait for the right trade deal and you risk kicking the can down the road for years. 

Speaking at an event in London yesterday night following the printing of the paper, Johnson moved to favour the latter option and not to rush into a deal with his similarly floppy haired counterpart across the pond. The candidate for PM, when speaking about the potential for a deal, claimed “it’s not something that’s going to be done instantly”. On a horrific day for the Pound in markets where implied volatility jumped through the roof and the spot value of the currency fell sharply, Boris also suggested it won’t add a huge amount to GDP quickly but will support the economy over time. Reacting to the scene again this morning European trading is more volatile than in previous day with a mild recovery in the Pound, leaving the currency just shy of its 27-month lows. 

The South African Reserve Bank will publish its latest monetary policy decision today. The expectation is for the monetary policy authority to cut rates in the face of sluggish economic activity where a rising proportion of debt repayments versus total household income is now as high as 9.3% in Q1. The incumbent interest reward continues to feed a huge Rand appreciation as a result of the profitability of a carry trade, however, with global tightening in focus, South Africa cutting rates in unlikely to distort those metrics immensely. Surprisingly, therefore, a rate cut probably won’t hurt the Rand as much as it might be thought to. 

It’s been suggested that over the next two quarters, the rate of return from the South African (private) Central Bank will fall to 6%, from its present lofty heights of 6.75% before pausing to observe the effect. With the best part of 50 basis points worth of cuts for the rest of 2019 still priced into US rates this week, the start of 2020 would, de facto, still see the interest rate premium of South African rate products over US products at 4%. Therefore, presuming that monetary policy adjustments announced following the conclusion of today’s SARB meeting aren’t overwhelmingly severe, there is still room for the Rand to continue the appreciation that it has delivered in the past couple of months. 

A lower rate of exchange would, all other things equal, boost economic activity as SA assets abroad become relatively cheaper, boosting demand. However, given the stock of hard debt (public borrowing repayment obligations denominated in foreign and more stable currencies) the State’s fiscal sustainability must also be brought into the frame. So it’s not really all things equal – if the Rand’s value falls too far and the central bank cuts too heavily today, then SA’s ability to repay debt in foreign currency also falls heightening the risk of a Moody’s ratings downgrade and the exodus of billions in investment grade bond holdings. For a consistently underperforming, squabbling and late Central Bank, there’s a lot to play for today.

Discussion and Analysis by Charles Porter

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