Author Archives: IJGResearch

By Rowland Brown

On the 28th of June, we sent the below out to a number of clients, as we amended our views on the regional fixed income space:

The situation in the UK is being massively overplayed in our view, as have been the market reactions. There is unquestionably a great deal of uncertainty in play at present, but a lot of this appears to stem from the wholly inaccurate view that Britain has to leave the EU NOW and has no plan as to how to go about this. In reality, Britain will choose when it wishes to invoke article 50, having gauged the will of the people to do so, through the referendum. The referendum is a domestic matter. The decision as to when this article is invoked is a domestic matter. It is not the business of the EU any more than the referendum was their business. Once triggered, the EU will take over, and the eventual British exit will be configured.

Britain thus has time to develop its side of the strategy to exit from the block. Given that an IN vote was broadly expected, it is hardly surprising that detailed plans have not been drawn up as to the process given that the OUT vote ultimately succeeded. Moreover, there doesn’t appear to be any good reason as to why there should have been such a plan – there is no rush to invoke article 50.

Great panic has befallen the country, largely because of the vast unknowns, with most people appearing to assume the worst. Many seem to expect the sky to come tumbling down any minute, while others expected to be denied entry into mainland Europe on their upcoming summer holidays. Few seem to have grasped the fact that nothing has changed, at least for now. Leadership through the uncertainty, has been all but non-existent. Cameron, still the official leader of the country in theory, has shown little practical leadership since Thursday night. Nevertheless, the uncertainty that has been allowed to prevail will likely drive a slump in consumer and business confidence, driving reduced consumption and investment activity in the UK in the immediate future. A conspiracy theorist (which I am not), would perhaps dare to suggest that this was a concerted effort to ensure that the disastrous economic predictions of an exit vote materialise. More realistically, however, it appears that Cameron is just not yet ready to give up the hot seat, but also not able to fill it. And understandably, few seem desperate to take it from him.

Nevertheless, all of this, particularly the expected growth slowdown, makes it likely that we will see interest rates stay lower for longer, and will probably see a rate cut in the UK before year end. Similarly, it appears less likely that the US will hike rates again this year (in fact, the market is pricing in an increased probability of a cut in Q3 or Q4 2016). Lower for longer makes fund flow reversals out of advanced economies into EM likely, and we may just see some significant EM currency strengthening over coming months.

For the region, this would be good news, at least in the short term. Inflows would obviously drive a stronger ZAR, which would in turn improve inflation expectations in South Africa, and would likely mean that we have reached the top of the interest rate cycle (although there is a slight chance we will see one more hike should this ZAR strengthening take time to materialise). This would provide a more stable footing for South Africa from a macroeconomic perspective, and may help to delay or avert a rating downgrade (perhaps an outside hope). In turn, we expect to see an increase in demand for SA government bonds in the second half of this year, resulting in stronger pricing. With benchmarks strengthening, Namibian yields will also likely see some compression.

This view has been playing out to the T over the past two weeks. Last week saw the largest EM debt inflows on record, as foreigners crowded into attractively priced EM debt on the assumption that interest rates will remain on hold in the US and Eurozone, and come down in the UK before year end.

As we suspected, following the knee-jerk on the USD, the Rand has been gaining back lost ground. In addition, the GBP has tanked, resulting in relative Rand strength. This Rand strength is unlikely to wane soon in our view, and we may just see strong buying pushing the rand back below 14 to the USD again.

Moreover, bonds prices have started to pick up, and yields right across the SA curve have been coming down. We expect this trend to continue going forward, at least for the next few months. The reason for this is simple – SA (real) yields are incredibly attractive when compared to much of the rest of the world. As the UK and Eurozone outlooks deteriorate, and as the Rand strengthens (and thus SA’s short term outlook improves), SA becomes relatively more attractive. Yields around 9% (real of 2.5 – 3%) on 10 year paper remain attractive when much of Europe’s debt is trading negative (both nominal and real), and for first movers, there is likely to be a pleasant FX gain on offer as well.

What all of this means is that we believe that we are at, or very close to, the top of the current interest rate cycle, or at least we should see rates on hold at these levels (or perhaps 25bp higher) for the rest of the year. This should prove positive for the economies of both South Africa and Namibia. Both economies are struggling to find growth at present (a short term normalization in Namibia’s case, and structural in South Africa’s case) and a little help from more stable interest rates won’t go amiss. Lower or more stable rates will help corporates, households and government when it comes to funding consumptive and investment activity. Moreover, lower rates and a stronger exchange rate will reduce consumer price pressure, thus allowing for a little more discretionary disposable income.

Broadly speaking, we feel that all of the madness that has ensued following the announcement of the Brexit vote has not been, and is unlikely to be, as unfavorable for Namibia and the region as many are making it out to be. In fact, we believe we may have been thrown a bit of a lifeline. Time, however, will tell.