It was always, always, going to happen. Fortunately it has taken the less-hawkish ratings agency of the three (seen from a historical South African context at least) to draw the battle lines. On Wednesday morning Moody’s changed the outlook on South Africa’s government debt ratings to negative from stable, citing three main reasons for the revision. These are:
1. The higher debt burden, especially when including contingent liabilities;
2. A slower economic growth outlook;
3. Political debate around economic transformation, including the debate on nationalization.
In our books that makes it two from three issues that we are the cause of (and although US and European politicians should carry the bulk of the blame for the slower growth outlook for South Africa, our politicians could do more to assist in the recovery).
Given government’s infatuation to control large parts of the economy through state owned enterprises, it continues to look the other way as these monoliths either lose vast amounts of money and then look for bailouts (they term them recapitalizations, though), or even worse, continue to fail miserably in providing affordable infrastructure and services.
As for the political ‘debate’, the level of maturity in some of the commentary around policy issues including nationalization and the economic ‘emancipation’ of people is finally proving to be a leading cause for the decision to revise our ratings outlook.
We should be quick to add that this by no means should be seen as a massive negative for South Africa. Moody’s currently has South Africa rated a notch above that of S&P and Fitch.
It should, however, be seen in the context of the risk of fiscal slippage for the sake of appeasing voters. It’s called buying votes.
Fixed Income
The price action in the aftermath of the Moody’s announcement (both in the Rand, as well as local fixed income and equities) highlights clearly how the Global Financial Crisis has impacted market psychology. Not so long ago an announcement of this nature would have easily caused a 30-50 basis point sell-off in bonds, a 50-cent move in the Rand and at least a couple of percentage points off the ALSI. On Wednesday the market hardly took notice. Bonds sold off maybe 5-6bp, the Rand lost a couple of cents at worst and equities were just about unchanged. In fact, Italian bond woes appear to be having a much bigger impact, proving that South Africa markets are currently just a play on European politics.
Therefore, these days the average market participant almost purely looks at such a move as confirmation that political ineptitude is and will remain the cause of anemic growth for some time to come. And perhaps furthermore that, because fiscal policy has largely become compromised, it will be expected of monetary authorities to do much of the heavy lifting.
We must therefore expect that accompanying another likely very dovish MPC statement Thursday will be a strongly-worded sideswipe at government that it needs to ensure that those risks highlighted by Moody’s are addressed. We are very much in agreement with the SARB that monetary policy is not the panacea for South Africa’s on-going structural growth constraints.
The fixed income market is now within a whisker of record lows, at least in the front end of the yield curve, as traders fear the risk of a surprise interest rate reduction at today’s MPC meeting. While this may be a potential buy-the-rumour-sell-the-fact rally, the recovery in especially foreign turnover statistics after the aggressive liquidation in September shows that we remain one of the few high-yielding options globally.
Therefore, for choice, South African rates in the 10-20 year area do offer value in the >9% zone, the caveat that of adequately addressing Moody’s concerns. Until such time we will continue to face a very steep yield curve.
Global
It would appear that European policy makers are fast running out of fingers to prop the holes in the dam wall. With Italian 5-year yields slicing through 7%, taking the spread to Bunds over 500bp, not even the very good news that Berlusconi has at last done the right thing by falling on his sword seems able to stop the rot that is now setting in. As the crisis continues to move ever closer to the last act we will have to also start paying attention to France and Germany.
The steady downward revisions to the European growth outlook are now reaching depressing levels. (We note that Italy’s yield curve is now inverting.) Unless we see something close to a miracle, Europe will be going into a recession shortly. The impact of this, if not contained, holds much risk to the global economic outlook. Therefore, while the US continues to surprise to the upside of downbeat consensus forecasts, the risk is on the increase that this could be transitory, and that 2012 is going to be a repeat of 2009. In other words, we stand the risk that the global economy goes into recession again for the second time in 3 years.
While we have beaten this drum to death, China remains the elephant in the room from our vantage point.
FX
Risks on the Rand are rapidly on the rise. Over the past two months foreigners have been accumulating local debt very aggressively again, and this still appears largely unhedged. Furthermore, the combination of Moody’s comments on South Africa, S&P comments on Hungary (watch this one closely… we may even see HIKES here), and Italian bonds now in a tailspin, the ‘risk-on, risk-off’ game has just ratcheted up a notch.
This makes for an extremely tricky backdrop for the SARB’s MPC to maneuver.
Given that South Africa, together with the likes of Mexico, Poland and Indonesia are currently extremely high beta plays to global liquidity, the risks posed by Europe in this regard are clear to see. Risk premia in emerging markets have seen the life squeezed out of it. Consider that the third biggest bond market in the world, Italy, currently sees its 5-year CDS spread at 550, versus that of South Africa’s 190.
Therefore, for choice, the next major move in the Rand (this is a short-term view only) is unlikely to be the downside. Tail hedgers should take this into consideration.
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