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Sunday, February 1, 2009

Following the first 50 point rate cut last December, markets discounted another 400 points by 3Q2009. That presupposes cuts of 100 points per SARB meeting in February, April, June and August.

Those are very precise numbers. It presumes CPI inflation collapses from 13.7% peak last September to below 6% BY June, even resurrecting feisty real rates. Many quoted observers favour 300 points of cuts, though taking all 2009 getting there, averaging 50 points per meeting. Adventuresome souls suggest some meetings of 100 points (running out of cutting runway before yearend).
What would be the SARB’s preferred number? For some on the Committee it may always be too much, for others plausibly too little. Happily for them they need not divulge their thinking before time.
Perhaps I have been reading too much Thermopylae this festive season (Tom Holland’s Persian Fire, the first world empire and battle for the West).
But the way 298 out of those 300 perished (one was sick, the other out on an errand, both afterwards branded as cowards) does make the 300 number rather a noble one.
But why not 600, another noble number, harking back to the Crimea War (“into the valley of death rode the six hundred”)?
Which brings us to the meat of the matter. Financial markets at any moment reflect the reckoning of many traders, weighing possible data outcomes.
Non-trading observers have more leeway taking into account things plausibly preoccupying policymakers, though without carrying ultimate responsibility and inconveniently not knowing the future, something supposedly not hamstringing the SARB.
So what does 2009 really have in store? One is reminded of Mohamed Ali (‘dance like a butterfly, sting like a bee’). Being flexible and opportunistic when it counts, capturing the essential SARB rather well. So why should it be 400, 300 or whatever the SARB dreams about in the dark? Why not yet a different number?
For most of 2008 the betting about 2009 focused on 200. Just goes to show there is no constancy in this game. So why not ere long on 600?
The markets might get to a 600 discount quite quickly for 2009. It all depends on reality and the odds. Both these are moving rapidly.
The world is going through its severest recession in 100 years. Commodity prices are still easing. Deflation will rule for most of 2009 in two-thirds of the world economy, prices falling. South Africa could be importing deflation as a consequence. If that is accompanied by rand firming on the back of dollar weakening, the inflation surprise of 2009 could be heavy undershooting after spectacularly overshooting during 2008.
Don’t be too concerned about second round. Local recession and intensifying global competition suppress our pricing impulses. Wage bills will be kept down as profit margins suffer. Even unionised labour will follow inflation lower in lockstep.
So do our money and capital markets still have downside yield potential after last year’s aggressive discounting? Well, yes. Global safe haven preferences, low inflation anxiety and policy aggression favouring quantitative easing suggest very low long yields for industrial countries, making even our 7% yields look attractive, especially as the rand is fundamentally undervalued with firming potential.
If our CPI isn’t destined for merely 6% but goes actually much lower, imagine the overheated expectations this heady brew could concoct. Even our bond market could still end up with mid-single digit yields.
Non-trading observers could take longer getting there, guided by lagging historic inflation, taking their time shifting entrenched positions, bearing in mind any SARB cluck-clucking.
The SARB would be irresponsible to cut rates too far and encourage another consumer boom, with as a starting point a current account deficit of 5%-7% of GDP. But then what to do if the current account became over funded, asset markets overbought and rand overly strong, undermining already weak export capabilities?
Certainly last time (2003-2005), and not for the first time, we took the road of least resistance, lustily cutting rates, getting domestic spending and imports up, going for growth, and reaping whirlwinds (2007-2008).
We didn’t then salt away all excess dollars in external sovereign wealth funds, though we boosted reserves. Mostly, we opted for maximum growth and risk. Perhaps not this time, though enthusiasm for sterilisation of excess capital inflows appears limited. There is the notion, however, that this time we will be more careful.
So it is going to be an interesting year, in which outreaching markets (600, anyone?) could increasingly range ahead of lagging observers (300-400) which may be caught at every SARB meeting as policy feet are cautiously dragged, limiting cuts to 50, aiming perhaps for 200-300 overall.
Conceivably, this could end up firming the rand, suppressing inflation, enflaming markets and observers yet more as the year unfolds. What then? If not more rate cuts, perhaps more reserves? Perhaps even a wealth fund? Pray for fewer global windfalls perhaps?

Copyright © Insurance Times and Investments® Vol:22.2 1st February, 2009
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