Remarks by Daniel Mminele,
Deputy Governor of the South African Reserve Bank,
at the annual Financial Markets Department cocktail function
Pretoria
4 April 2017
Good evening, ladies and gentlemen.
It is once again that time of the year when we welcome you all to the annual cocktail
function of the Financial Markets Department of the South African Reserve Bank
(SARB). Thank you for accepting our invitation and joining us tonight.
Introduction
As you are aware, the main idea behind this function is to create a networking
opportunity between SARB staff members and other market participants in order to
facilitate an exchange of views on financial market developments in a more relaxed
environment. This annual event also provides an opportunity for us as the central
bank to convey our appreciation for the cooperation we have been receiving from
market participants over the past year, both in the execution of open market
operations and when we conduct financial markets research to enhance our
understanding of market dynamics. These interactions are crucial for our role in the
financial markets as we seek to give effect to the monetary policy stance which
underpins the execution of our price stability mandate.
My colleagues in the Financial Markets Department remind me every year that this is
my 'speech of the year'
not the occasion to deliver but that I am merely a curtain-
to the main event, namely conducting 'special'
raiser liquidity management
operations.
In welcoming you to the SARB, allow me to make a few remarks to take stock of the
recent developments in international and domestic financial markets and their
last year's
implications, cocktail function being the reference point. Before I conclude
I would also like to touch briefly on market conduct issues. I will try and heed the
gave: "Be sincere, be brief, be
advice that Franklin D. Roosevelt once seated."
Developments in global financial markets
Since the previous cocktail function, policy uncertainty has come to dominate price
action in global financial markets. Among other things, this is due to what Marvin
has called the 'politics of
Barth rage'1, referring to the rise in anti-globalisation
sentiment, populist rhetoric, and countries increasingly turning inward. While an
element of this uncertainty may have diminished, at least as far as the election
outcomes in certain parts of the world are concerned, the outcomes themselves
have ushered in a period of unusually high levels of uncertainty as regards policy
direction, the timing with regard to the adoption of policies as well as the likelihood of
successful implementation. The risks stemming from the possible election outcomes
across Europe this year appear to be receding, but one thing last year taught us is
that impossible things are possible.
As a result of this, global financial markets may well be in for further bumpy rides, not
least because market risk indicators such as high-yield corporate bond spreads, the
spread on foreign currency emerging market debt, and general equity market
- -
volatility which often reflect investor nervousness remain low, pointing to a
possible dislocation that could understate the downside risk profile to economic
growth. Nevertheless, as is the norm, markets have moved ahead of 'the fact', for
instance pricing in a higher trajectory for US2 economic growth. Analysts expect real
GDP3 in the US to average 2.2% in 2017,4 more or less in line with the median
projection of the Federal Open Market Committee (FOMC). The positive momentum
in terms of growth prospects is not confined to the US and is relatively broad-based,
particularly when it comes to advanced economies.
Against a backdrop of an improving growth trajectory, economic policy uncertainty
presents a new challenge for the already complex environment in which central
-
banks operate more so because the actual and expected inflation figures are
seemingly on an uptrend. For central banks, who have said for so long that rising
inflation is a necessary precursor to 'normalising' their policies, the macro-financial
implications of this increasingly uncertain political environment could complicate
monetary policy normalisation. As the forward guidance thresholds are being
reached, the question remains whether central banks (specifically those in Europe)
will once again re-emphasise the broader notion of economic slack that may result
from the current political landscape as an additional qualitative feature of their
headline inflation that is now above the central bank's
policies. The UK5 facing
official target and, on the other hand, threats to its economic growth is a classic
example. The US is in a slightly different position. Having gradually lowered the
projected path of its policy rate since the time of our previous cocktail function, the
FOMC changed its course in September 2016 and revised upwards the future path
of interest rates that it deems most likely to foster outcomes for economic activity
The FOMC's projections
and inflation that best satisfy its dual mandate. now point to
two additional 25 basis point increases in the federal funds rate following the March
hike. These expectations are in line with those implied from Fed funds futures and
are also evident in the pricing of US currency and fixed-income markets. The US
dollar index has appreciated by 6.2% since April 2016, reflecting the change in the
outlook for US monetary policy. At the same time, the US Treasury curve has bear
flattened, with yields at the shorter end rising by as much as 60 basis points.
In the emerging market economies, things look slightly better than over the previous
last year's
year. Soon after cocktail function, we noted an increase in the universe of
negative-yielding bonds that, in an environment dominated by the search for yield,
benefited certain emerging markets. During this period, yields on emerging market
local- and hard-currency debt declined and equities rallied, but currencies presented
a mixed picture, although in most cases still with an appreciation bias. The rally in
by signs of stabilisation in China's
emerging market assets was largely driven
economy and financial markets, a rebound in energy and other commodity prices,
and more supportive central bank policies in developed markets. Furthermore, on
the back of the last-mentioned, net capital flows to emerging economies (excluding
China) peaked at US$26.1 billion in June 2016, according to estimates by the
Institute of International Finance. However, after this June peak and for the
remainder of 2016, the build-up to and outcome of the US presidential election
sparked a wave of outflows from emerging markets, with portfolio flows estimated to
have plummeted to a 41-month low as the so-called 'Trump Trade' favoured a
stronger US dollar and higher US yields. Emerging market capital flows have since
rebounded across the major developing regions but potential headwinds persist,
especially given that it cannot be argued that such were in any way related to a
change in economic fundamentals.
Developments in domestic financial markets
Price action in the South African markets was more or less in line with that of other
developing economies. The most notable development has been the strengthening
of the rand which, by last week, had appreciated to a low of R12.31 against the US
dollar since our previous cocktail function. This was the strongest that the rand had
traded since mid-2015. On a trade-weighted basis, the South African currency had
appreciated by about 19%.
This rally can be attributed to a number of factors, including the pickup in commodity
prices, investor positioning, and a reprieve from international credit rating agencies
regarding a possible downgrade of South Africa to sub-investment grade. The rand
was also supported by more favourable terms of trade and an improvement in the
current account balance that has reduced the perceived vulnerability of the currency
to possible capital flow reversals. This made the rand more resilient even during
externally induced risk-off episodes, appreciating alongside a stronger US dollar
and/or depreciating by less compared to its emerging market peers.
Other financial assets followed a similar path of appreciation over the year. Bond
yields rallied and breakeven inflation declined. The yield on the benchmark
R186 bond had declined from just over 9% a year ago to a low last week of 8.32%
while breakeven inflation on the R197 (5-year) inflation-linked bond declined from
7.2% in April last year to around 5.8% last week. With the lower inflation
expectations, the (FRA) market had, by last week, priced in more than one rate cut
by the first quarter of 2018, with the 12x15 FRA trading below 7.0%.
The Monetary Policy Committee (MPC) noted the improvement in the inflation
outlook, which over the past year had allowed multiple downward revisions to the
forecast, and expressed last week, at the conclusion of its most recent meeting, the
view that we may have reached the end of the moderate tightening cycle. According
to our most recent forecast, we expect headline inflation to fall below 6% in the
second quarter of 2017 and to remain within the target range for the remainder of the
forecast horizon. Notwithstanding the fact that there was one member of the MPC
who preferred a 25 basis point reduction in the repo rate at the March meeting, the
general feeling was that evidence of a more sustained improvement in the inflation
outlook is required before interest rates can be reduced. The MPC remains
concerned about the elevated levels of inflation expectations that are still around the
upper end of the inflation target band.
As you are aware, some of the positive trends we had been observing were
interrupted by political events during the last week, which triggered a significant
movement in the financial markets. Since last Monday, the rand traded in a range of
163 cents, between its strongest level of R12.31 to the dollar on Monday and its
weakest level of R13.94 around midday today. The currency did, however,
appreciate somewhat and was at levels of around R13.55 to the dollar earlier this
afternoon. The R186 yield also lost most of the gains it had made last year and is
now trading at just above 9.0%. The 12x15 FRA is back to 7.49%, implying an
unchanged repo rate for next year.
Financial markets will likely need more time to fully process the recent political
events and their economic consequences. It remains to be seen whether the recent
market developments represent a reassessment or a repricing of the South African
credit. It is similarly too early to draw any firm conclusions on how these
developments will affect SARB's own inflation forecasts. The MPC has previously
cautioned that, should some of the factors which had contributed to a more
favourable outlook reverse and undermine the inflation outlook, it may reassess its
views; the MPC stands ready to respond appropriately in line with its mandate
should the need arise.
Yesterday's decision by S&P Global Ratings to lower
South Africa long-term foreign
currency sovereign credit rating to sub-investment grade, with a continuing negative
outlook, is a serious setback for the country. We will now need to redouble our
efforts in providing assurance and communicating continued commitment to sound
macro-economic policies and their consistent and predictable implementation, so as
to reverse the current ratings trajectory. This will require a continued collaborative
effort between Government, business and labour to boost domestic and international
investor confidence.
Market conduct developments
Before I conclude, let me touch on an issue that has been receiving some attention
recently. While it is true that traders and investors need to continually evaluate the
fundamental drivers of asset prices, the behaviour of market participants should
always meet the highest conduct standards. Ensuring and continuously promoting
adherence to high standards of ethical conduct is an integral part of contributing to
the efficiency, integrity and reputation of our financial markets.
The Competition Commission of South Africa has referred for prosecution to the
Competition Tribunal allegations of collusive and therefore unlawful practices among
certain financial institutions in their foreign exchange trading operations involving the
rand. As stated previously, the SARB views these allegations in a very serious light
and is of the view that those found to have violated the law should accept full
responsibility and bear the consequences. However, it is also important that we do
not jump to conclusions and allow the steps now initiated to be completed, following
due process.
Building on the review of foreign exchange operations of local authorised dealers
conducted in 2015, National Treasury, the Financial Services Board and the SARB
will soon embark on a more comprehensive review of conduct in the wholesale
money, debt capital, foreign exchange, commodities and derivatives markets in
South Africa in order to strengthen market conduct. The exercise is expected to be
similar to the Fair and Effective Markets Review conducted in the UK. The review,
which is scheduled to commence next month (with further details to be announced in
standards and practices in South Africa's wholesale
due course), will look at the
financial markets, both regulated and unregulated, in terms of governance,
accountability and incentives; it will ultimately develop recommendations for overall
conduct standards to enhance the integrity of our financial markets.
The Bank for International Settlements is in the process of developing a Global Code
of Conduct for Foreign Exchange Markets which will set out the principles of good
practice in the foreign exchange market. The code will be released on 25 May 2017.
The SARB participated in its development and is now in the process of consulting
with a wide range of market participants via the Foreign Exchange Subcommittee of
the Financial Markets Liaison Group with the view that South Africa should be an
early adopter of the code within any proposed time frames.
Conclusion
Let me conclude by once again expressing, on behalf of the Financial Markets
Department and the entire SARB, our appreciation to all the market participants for
their cooperation and support over the years. We look forward to continuing our
interactions in the future.
I would like to thank our financial markets team for the sterling work over the past
year, for their dedication and commitment to the task.
Allow me to also draw to your attention some changes that have taken place in the
senior management of the Financial Markets Department. In preparation for the
upcoming retirement of Mr Callie Hugo in 2018, with effect from 01 April 2017 Callie
assumed the role of Special Projects Manager in the office of the Head of
Department. Mr Zafar Parker, who previously headed up our Reserves Management
team, has taken over from him as Head: Market Intelligence and Operations this
week. While Callie still has his work cut out for 15 months or so, it is only proper that
we already thank him today for his tremendous contribution in guiding our money
market operations over many, many years.
Thank you also to our staff at the Conference Centre for organising this event.
FMD Update
As in previous years, a newsletter called has been prepared for the
occasion, which provides information on some of the key strategic initiatives that the
Financial Markets Department is involved in. It is available for you to take home, but
you can also find it on our website.
Thank you for your attention. Enjoy the rest of the evening.