Traders Swerving on South African Rates Now Bet on Cuts (January 19,2015)

(Bloomberg) -- In the course of a week, traders of South African derivatives went from betting
on higher borrowing costs to a reduction, and as soon as this month.
Forward-rate agreements, used to speculate on interest rates, show investors see more chance of
a cut than an increase over the next two quarters, the first dovish occurrence since May 2013.
Wagers have flipped amid market expectations for inflation at the lowest level in more than two
years.
A slump of almost 60 percent in crude prices since last years peak in June is driving down the
cost of fuel in South Africa, helping to keep inflation within the central banks target range at a
time when the economy is expanding at the slowest pace since the 2009 recession. Speculation
that rates may fall in emerging economies is increasing as the European Central Bank weighs
news stimulus and after Swiss policy makers abandoned the francs trading cap on Jan. 15.
If the rand behaves and oil stays where it is we are in a totally different scenario, Abri du
Plessis, who helps manage the equivalent of about $460 million at Gryphon Asset Management
Ltd. in Cape Town, said by phone at the end of last week. Then there will be an opportunity to
cut, and we need that from a growth perspective.
Forward-rate agreements starting in July dropped 10 basis points to 6.06 percent in Johannesburg
on Jan. 16, or 6.5 basis points lower than three-month Jibar. As recently as Jan. 15, the contracts
traded above Jibar, signaling a rate increase. Contracts starting in 12 months fell 13 basis points
to 6.21 percent, bringing the decline since the beginning of the year to 75 basis points.
Easy Policy
FRAs tend to overreact one way or the other, but yes, what this tells you is that it would be very
difficult for the Reserve Bank to hike rates, Johann Els, a senior economist at Old Mutual
Investment Group Ltd., South Africas biggest private investor, said by phone from Cape Town
on Jan. 16. It would be risky to cut rates, but the combination of easy monetary policy globally
and low inflation locally means the Reserve Bank can leave rates on hold for longer.

The Reserve Bank has kept its benchmark interest rate unchanged since July, when it was raised
by 25 basis points to 5.75 percent. Rates would have to normalize over time, Governor Lesetja
Kganyago said on Nov. 20, after the last policy meeting of 2014.
The consumer-inflation rate probably dropped to 5.5 percent in December, a report may show on
Jan. 21, according to the median estimate of 14 economists in a Bloomberg survey. The rate may
fall as low as 4 percent in coming months, meaning the policy rate would be above inflation, or
normalized, without an increase in borrowing costs, Du Plessis at Gryphon said.
Rolling Blackouts
Domestic gasoline prices fell 9.9 percent in January after dropping 5.5 percent a month earlier.
Yields on rand-denominated debt due December 2026 fell nine basis points to 7.38 percent on
Jan. 16, the lowest on a closing basis since May. The rand weakened 0.9 percent to 11.6577 per
dollar at 3:07 p.m. in Johannesburg on Monday.
Government forecasts indicate the economy expanded 1.4 percent in 2014 and will grow 2.5
percent this year. State-owned utility Eskom Holdings SOC Ltd. warned on Jan. 15 of almost
daily rolling blackouts until the end of April across the countrys cities as it struggles to meet
demand. Three months of continual power cuts could shave as much as 1 percentage point off
growth, according to Matthew Sharratt, an economist at Bank of America Corp.
Our current base case is that rates in South Africa will remain unchanged through year-end
2015, Bernd Berg, an emerging-markets strategist at Societe Generale SA in London, said via email. Looking at the disinflationary and sluggish growth picture, I would not exclude a dovish
surprise from the central bank.