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SA Reserve Bank unleashes QE as COVID-19 weighs on the local bond market

26 March 2020

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by Nolan Wapenaar, Co-Chief Investment Officer

In a surprise announcement on Wednesday (25 March), the South African Reserve Bank (SARB) said it would buy an unspecified amount of government bonds, with SARB Governor Lesetja Kganyago stating that the SARB was “… adding liquidity to facilitate the functioning of the SA financial system, …”. In our view, the move is both unexpected and positive. We view the decision as basically being quantitative easing (QE) by government. QE happens when a country’s central bank introduces new money into the market by purchasing government bonds or other securities to increase money supply and encourage investment. In this note, we provide more details about the SARB’s intervention.

The SARB did not mention details around the scale, and timetable, of its intervention in the announcement. However, the bank did state that the move was required to provide liquidity to the bond market at a time of severe stress, so we would presume that the SARB will only step in again if it sees a repeat of days like Monday (23 March) and Tuesday (24 March), when the yield on the 10-year SA government bond spiked to above 12%. We expect this to be an open-ended commitment from the SARB to support the smooth functioning of the local bond market.

In terms of the consequences of the move, both intended and unintended, from our viewpoint the bank has achieved its primary objective of getting two-way liquidity into the bond market by bringing the bid/offer spreads down to more reasonable levels. Certainly, the market has not fully recovered, but it is at least functioning better.

The SARB has underwritten the liquidity in the market. At times of stress the bank will buy bonds. Imagine that you are a US hedge fund needing to sell something to raise cash immediately. You have a liquidity put against the SARB. In this case, the bank will also support prices, thus making these types of sales less painful. At times of financial stress, investors sell what they can sell with the least impact and, going forward, that will include SA bonds. We therefore expect foreign selling of SA bonds to be higher during times of financial stress. This also means that the rand will depreciate further against the US dollar and other major currencies at these times as foreigners repatriate their proceeds from a sale.

Looking at the sustainability of the SARB’s bond buying, we note that if this is done only for the purpose of supporting the market at times of massive stress, then it is a positive move. Sometimes, just knowing that you have a backstop is very important and, as a result, you don’t necessarily use it that much. We suspect that this is the case currently and that the move is most probably intended to provide support to the local market going forward.

Because the SARB is buying bonds in the secondary market only, it will have no impact on the fiscus. Nevertheless, there are some risks that we are concerned about given the current intervention. These include i) the fact that such an intervention will increase the volatility of the rand; and ii) politically, it might be easier to move towards QE in order to extinguish some of the national or Eskom debt. However, in our view, as tempting as this option might be it would be a disastrous move on the part of government.

Given the SARB’s intervention, we highlight the following in terms of the investment opportunities available. The R186 bond is now trading at around 10.50%, which we think is still extremely cheap. Investors can lock-in CPI +6% in the 6-year government bond. This is a fantastic opportunity for lower-risk mandates. In addition, we see obvious value in the domestic market and among the listed property stocks, although we would advise investors to be careful to ensure that they hold a portfolio of companies with high-quality balance sheets.

 

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