First Strut: South Africa's First Corporate Bond Default

Corporate default is described as a deceptively rare event. This is especially true in South Africa where the generally high quality of corporate bond issuers has meant that until now there have not been any defaults in the listed bond market. We avoided investing in this bond for our portfolios, and the rationale for this is spelled out in an article i wrote for Nedgroup Investment's quarterly newsletter:

http://nedgroupinvestments.co.za/insights/Single/660

Rashaad Tayob

The Central Bank Dilemma: Inflation vs Growth

Today I attended a meeting with an official from the South African Reserve Bank (SARB). It was a good opportunity to get some insight into their thinking given that the current stagflationary environment (the combination of low growth and high inflation) places conflicting demands on monetary policy. Low growth necessitates loose monetary policy, while inflation above the 6% upper target implies the need for rate hikes. Interest rates were left unchanged at last week's (19 Sep 2013) Monetary Policy Committee (MPC) meeting, but the Governor Gill Marcus gave a distinctly hawkish speech, which hinted at the real possibility of rate hikes in  the coming months.

I have long held the view that interest rates at 5% in SA are too low given the 3-6% inflation target and the fact that inflation is likely to remain close to or above the 6% upper threshold for the foreseeable future. A few months ago the dominant sentiments was that rates would remain low for an extended period due to the global interest rate environment. Despite a significant depreciation of the Rand and the ensuing inflationary pressure, in April 2013 the market had moved to price in a further rate cut.

This all changed in May when the Fed announced the potential for reduction in the bond purchases (tapering of quantitative easing), which caused the Rand depreciation to accelerate and yields to spike. While the market has since settle, the consensus view has been that a weak economy would preclude the need for rate hikes.

Last weeks MPC had economists scrambling to amend their interest rate forecasts as the MPC’s language seemed to be aimed at preparing the market for a rate hike in the coming months. Like all Central Banks, the SARB has to find a balance between controlling inflation and promoting growth, but in the last meeting the governor repeatedly reminded the market that maintaining inflation within the target band is the Reserve Bank’s primary mandate.

Given the outlook for continued inflationary pressure due to the depreciation of the Rand, as well as the shift in the Reserve Bank's focus back towards controlling inflation, I would not be surprised if the rate hiking cycle starts in the coming months.

A Public Service Announcement (Brought to you by a billionaire hedge fund manager)

Ray Dalio is the founder and head of one of the most successful hedge funds in the world. I first heard of him when i read his "Principles" document, which explains his belief system and how he incorporates these beliefs into the management of his his company. I was quite taken by this document and as a director of a small investment management firm I attempted to replicate several of the "principles" in our company.

http://www.bwater.com/Uploads/FileManager/Principles/Bridgewater-Associates-Ray-Dalio-Principles.pdf

Dalio doesn't appear in the press too often, but when i have heard him talk, his view his views on investments has been insightful. He has spoken before of the economy as a "machine" and he has now distilled his understanding into simple 30 minute YouTube video. Much of the content will be familiar to those in the markets, but the clarity with which the economic cycle is explained makes it worth watching regardless of one's level of financial understanding.

Currency Confidence Tricks

The beleaguered Rand has found some support in recent days, partially due to a resolution of several strikes in the mining sector, as well as a further announcement of the BRICS (Brazil/Russia/India/China/South Africa) "Contingency Reserve Arrangement" (CRA) which is meant to provide support to Emerging Market (EM) countries suffering from severe currency depreciation.

http://www.bdlive.co.za/economy/2013/09/05/south-africa-to-contribute-5bn-towards-brics-contingent-reserve-arrangement

Talk of a CRA was brought up earlier in the year at the BRICS summit held in Durban, and the strategy seems to be that the idea will be revived any time EM countries come under pressure. The recent depreciation of EM currencies in the wake of Fed tightening fears was the perfect time to bring up the matter again.

It appears that the BRICS are mimicking the confidence tricks of central banks in the developed world, where forward guidance and the warnings of the power of central bank's balance sheets are often used to push the markets in a desired direction. The oft repeated Wall Street saying "Dont fight the Fed" reflects the market's view that one should never bet against the US Federal Reserve's ability to stimulate the economy and market, and this power has been assumed of Developed Market (DM) Central Banks in general. The European Central Bank (ECB) under Mario Draghi has been particularly successful in convincing the market of its power, with Draghi's "believe me it will be enough" statement to support the Euro in July 2012 helping to reverse the contagion that was underway in the peripheral European economies. Despite Draghi's limited ability to make good on his threats given the constraints of the ECB's mandate, the market's fear of central bank power was enough and the threat of action precluded the need for actual action.

This EM Currency Reserve talk shows that the BRICS have some way to go before they can flummox the market in the same way as their DM peers. A confidence trick in the central banking world requires assertiveness and the threat of aggressive action, but the vague announcement and extended time frames announced by the BRICS takes away much of the sting.

The BRICS announcement also suffers from a lack of credibility due to that fact that the BRICS circumstances vary substantially by country and they do not share a single currency. There is no ideal way to determine the quantum and timing of any intervention, which means that the support for individual countries is likely to be limited to their contribution. South Africa's $5bn contribution may as well remain with the South African Reserve Bank, who can choose to intervene in the currency markets should they feel it necessary.

The nature of the CRA announcements to date makes it seem unlikely that the fund will materialize as a central pool of assets, but would rather just be some form of non-binding pledge by the individual central banks. Any form of currency intervention is risky, and South Africa knows this as well as anyone given the experience of 1998 where then Reserve Bank governor Christ Stals squandered billions of dollars an attempt to stave of Rand depreciation. The lesson of 1998, 2001, 2006 and 2008 is that it is best to leave the Rand to find its own market level, given the difficulty of influencing a global currency market which trades over $4 Trillion a day. This attempted confidence trick lacks the necessary confidence, and is will therefore be quickly brushed aside by the markets.

Rashaad Tayob

The Prospects for a Social Pact in South Africa

Today I attended a discussion between Adam Habib and Judith February at the Open Book Festival in Cape Town. The topic was Habib's book, South Africa's Suspended Revolution, and the conversation revolved around Habib's view of the political and economic forces that have shaped post-apartheid South Africa, particularly the schisms that exist within society due to the level of inequality.  Habib's primary idea is that South Africa needs to develop a social pact between business, government and labour in order to make the compromises necessary to tackle the deeply embedded economic and social problems within the country.

Habib had harsh words for corporate leaders earning tens of millions a year while trying to push through 6% salary hikes for workers earning a few thousand rand a month. He also criticised the ANC as transitioning from a party of liberation towards an "enrichment mechanism for politicians and the politically connected". Habib believes that the poor have no leverage in the current political environment, and been the victims in this fight for resources between business and the state.

Habib is the newly appointed vice chancellor of Wits University, but I had heard him speak four years ago at a bank-organised conference and was impressed by solutions he presented for the South African economy. I have often repeated his idea that "South Africans should build an economy for the workforce we have, not the workforce we wish we had". Back then he had stressed the importance of a Social Pact, but in the ensuing years the progress has not materialised — and in fact, the malaise has worsened.

The question is whether there is sufficient leadership in South African government, business and labour needed to make the difficult decisions necessary to move the country forward. South African business since 1994 has been responsible for employment and wealth creation, but to date shown little interest in the long-term objective of creating a more equal and inclusive society. Businessmen would question whether this even their responsibility, but in the case that "suspended revolution" does materialise then those with capital the most to lose. The governing party has chosen to pursue various Growth and Development plans (NDP/NGP), which allow them to pay lip service to issues without having to actually do much. It would be better for them to focus on fixing the existing structures rather than creating new ones.

While it is tempting to rue the mistakes that have been made by both business and government since 1994, I believe that Habib's idea of a "social pact" has a big part to play in reversing the current course of the South African economy.

The Blog Resurrected

I started this blog almost two years ago with the intention of writing on the South African economy and fixed income markets. Over the years i have infrequently written commentary for clients, newspapers and magazines and this blog was an attempt to create some routine as i looked to improve my writing and increase my output. Unfortunately this blog, like 95% of blogs out there, died a quick death.

A short while after starting this blog i moved firms, joining ABAX Investments in early 2012. I continued to look after the same Fixed Income and Absolute Return funds that i had been managing for several years, but the processes of moving across to the new firm and taking on some new funds kept me quite busy, which meant that the blog was sidelined.

I have been meaning to restart the blog for some time and this article by Matt Phillips in Quartz finally riled me up enough to go through with it:

"The crisis enveloping India’s currency just got serious. Here’s how to stop it"
Matt Phillips
http://qz.com/119057/india-currency-crisis-rupee/

Matt Phillips's suggestions to combat India's currency crisis by "fighting the market", "borrowing" and "clamping down on flows" are some of the most counterproductive imaginable. The Indian response has been a poorly planned, with a string of makeshift policies which have only served to exacerbate the currency weakness. The challenges facing the Indian economy are similar to those in South Africa and this will be the focus of my comeback post due in the coming days.

Rashaad Tayob