Remarks by Daniel Mminele,
Deputy Governor of the South African Reserve Bank,
at the annual Financial Markets Department cocktail function
Johannesburg
10 May 2018
Ladies and gentlemen, good evening.
It is with pleasure that I welcome you to the annual cocktail function of the Financial
Markets Department (FMD) of the South African Reserve Bank (SARB), which is now
in its 12th year. We are greatly honoured by your presence tonight. The deal I struck
with our Financial Markets Department for moving this function from Pretoria to
Johannesburg was that I would be allowed to speak for 90 minutes.
Introduction
Allow me in welcoming you to this event, to make some brief observations about
financial market developments since we last met and to touch on what could be in
store for us in the period ahead. I would also like to draw your attention to two of our
initiatives that are gathering momentum, and which will require your cooperation over
the next few months. I know that our views on domestic monetary policy are always of
interest to financial market participants, but as we are on the eve of entering into the
closed period for our next Monetary Policy Committee meeting, which starts on 22nd
May, I shall refrain from any comments today, and ask for your patience until you get
our most recent take in about two weeks'
time.
The global financial markets backdrop
Since the last FMD cocktail function, global financial markets have had to ponder over
a plethora of developments, including the strengthening synchronised global growth
environment, changing perceptions around monetary policy normalisation, rising
financial market volatility, threats of escalating trade conflicts, and rising geopolitical
tensions. In many ways, the period since our last cocktail function to now has been
one of transition; from markets being very complacent about risks, to the current
environment in which risk-sensitivity levels appear to be rising again, even against still
relatively overall supportive financial conditions. The initial period was characterised
by volatility being subdued across a broad range of asset classes, in certain instances
with indicators touching record lows. While US interest rate futures increased to reflect
expectations that the Fed would hike interest rates, and also appeared to factor-in that
the US Treasury would issue more short-term debt, the anticipated pace of such
interest rates increases was expected to follow a relatively slow and gradual profile.
The other major economies were seen to be still somewhat behind the US with regard
to changes to their monetary policy settings. One puzzling issue for the markets had
been the fact that even with expectations for better growth in the US, further stimulus
coming from the implementation of tax reforms, both of which pointed to possible
further hike by the Fed, the USD was weakening. During this period of a relatively
benign global environment, capital flows to emerging markets also held up rather well.
We have now moved into a period where the market is adjusting to the strength of the
cyclical growth momentum that has started to put upward pressure on short-term
interest rates and push volatility higher. Adjustments to monetary policy by way of
policy rate increases and reducing the pace of asset purchases are now featuring
more prominently when assessing future developments. This has already been
witnessed with the 10-year US Treasury yield rising to the psychologically significant
-
level of 3% a level last seen, albeit briefly, in 2013. Now all market-generated paths
for policy rates suggest an upward trajectory. Concomitantly, the US dollar has been
regaining the ground lost previously, which had seen the USD reaching a three-year
low in February 2018.
Developments in the domestic financial markets
You are all very familiar with developments in the domestic markets, which will allow
me to be very brief. Prior to the recent dollar strength, but subsequent to the FMD
cocktail function last year, price formulation in the domestic financial markets reflected
a confluence of idiosyncratic and global factors.
The rand was range-bound during the second and third quarters of last year, trading
between R12.62 and R13.95 against a steadily weakening US dollar. The benign
global environment had to an extent helped shield domestic financial assets from
unfavourable domestic growth developments as well as political and policy
uncertainty. However, in the latter part of the year, domestic factors were more
to a year's high of R14.47
dominant and resulted in the rand depreciating in November
2017, before subsequently rebounding on positive sentiment towards domestic fiscal
and political developments as well as concomitant views from credit rating agencies
which included Moody's Investor Service
which were positively received by the market,
retaining South Africa's
sovereign credit rating at investment grade level and improving
A key factor in Moody's assessment was their
the outlook to stable from negative.
reduced nervousness about South Africa's
rising economic and fiscal risks, and higher
levels of comfort with regard to efforts to restore the strength of key institutions.
The strengthening rand led to a sharp decline in local bond yields, with the yield on
the benchmark R186 declining by 141 basis points to 7.98% while the 30-year R2048
bond's yield compressed by 146 basis points as investors repriced the political risk
premium. The five-year sovereign credit default swap spread improved by 60 basis
points from its peak of just over 200 basis points in November 2017.
In recent weeks, the rand has been relatively volatile with a weakening profile currently
trading around R12.40 to the USD. In line with developments in other emerging
markets, this development has been more reflective of USD strength rather than
exhibiting rand-intrinsic weakness.
What do we need to look out for?
While the degree of monetary stimulus of recent years has so far had surprisingly little
impact on inflation, the debate remains as to whether this pattern is likely to continue,
or rather at what speed any changes will occur, now that some economies are
operating with positive output gaps.
There are some concerns that the shift to higher volatility may not necessarily be
orderly against the background of fears of protectionism, increased geo-political risks,
and uncertainty over the pace of monetary policy normalisation. This may lead to an
abrupt tightening of financial conditions, which in turn may curtail global growth.
Even with some recent corrections, asset valuations remain generally stretched, and
currency mismatches arising from large amounts of USD denominated debt incurred
to take advantage of low rates (by both corporates and sovereigns), could make
financial markets vulnerable to financial conditions tightening at a faster pace than
currently anticipated.
At the most recent IMF/World Bank Spring Meetings another issue that received
particular attention was the rising level of global debt, which if unchecked has the
potential to trigger financial instability in the future, weighing on growth and
undermining financial assets.
These developments may harbour some serious implications for emerging markets.
Firstly, risk-aversion may reduce the attractiveness of the emerging market assets,
including carry-trade related transactions, which may negatively affect portfolio flows
to these markets, as witnessed in the sharp pull-back in flows since mid-April 2018.
Secondly, export-dependent emerging economies will be impacted as commodity
prices tend to fall when the dollar strengthens. Lastly, a stronger dollar would put
pressure on emerging markets with large dollar liabilities, further increasing their
financial vulnerabilities.
We have already seen some early signs of these risks materialising for emerging
economies, with a number of emerging market currencies, including the rand,
weakening not only to the dollar, but also to other advanced economy currencies, such
as the euro and the yen. But admittedly others have been tested a lot more when
compared to South Africa.
A key risk to the outlook on the rand remains the possibility of accelerated monetary
policy tightening by central banks in the advanced economies, particularly in the US.
Escalating trade conflicts and geo-political developments, present another risk factor
that needs to be monitored carefully.
The impact of trade conflicts could result in decreased demand for South African
exports and potentially higher volatility in currency markets.
Key initiatives to strengthen the domestic markets
Let me turn to the two major initiatives undertaken by the SARB to strengthen domestic
financial markets.
The first one relates to a consultation paper on selected interest rate benchmarks in
South Africa that we will be releasing in the next few weeks. This initiative partly
emanates from a coordinated response by international regulators and central banks,
to the instances of attempted and actual manipulation of key global interest rate
benchmarks and reference interest rates, in particular the London Interbank Offered
Rate in 2012. Consequently, the Official Sector Steering Group1, established under
the auspices of the Financial Stability Board, recommended that interest rate
benchmarks should be underpinned by transaction data and that risk-free interest
rates benchmarks should be developed to support certain financial instruments,
including derivative contracts.
This initiative was also informed by research conducted into the robustness,
representativeness and sustainability of the Johannesburg Interbank Average Rate
(JIBAR), given its wide usage as a reference rate in South Africa, especially the 3-
month JIBAR. The research indicated some shortcomings in JIBAR, which do not
allow it to fully perform its role as a key indicator of underlying market conditions. The
majority of floating interest rate securities and derivatives contracts are linked to the
JIBAR, which underscores JIBAR's importance in the transmission of the
three-month
SARB's monetary policy stance through the financial market channel.
This work is not
limited to the JIBAR, but covers selected other interest rate benchmarks in South
Africa. Following the release of the consultation paper containing certain reform
proposals, there will be a two-month period for comments, to be followed by a final
implementation document in due course.
I would like to call upon you to please engage with the document and provide us with
your comments. This is a very important initiative for financial markets development in
South Africa.
The second initiative that I would like to update you on relates to the work of the
Financial Markets Review Committee (FMRC). In the 2017 national Budget speech,
the Minister of Finance announced that the SARB, the Financial Services Board and
National Treasury had begun working on a comprehensive financial markets review
under the leadership of former SARB Senior Deputy Governor James Cross. The
objective is to review the standards, practices and issues of governance,
accountability and incentives in wholesale financial markets. The FMRC will consider
the mechanisms that are necessary to augmenting the implementation and
governance of conduct standards by market participants. Furthermore, it will identify
areas where changes to legislation are needed to support a new conduct framework
for wholesale financial markets.
One of the painful lessons of the great financial crisis has been the importance of
conduct in financial markets, and how poor conduct can end up being globally
systemic. It is therefore important that we strengthen domestic and global collaborative
efforts between the private and public sector, aimed at building trust as an important
contribution to creating effective, fair, and resilient markets.
The review is well underway and much progress has been made already. You may
have participated in the FMRC questionnaire or in meetings held by the project team.
It is envisaged, that a draft report will be published later in the year for public comment.
Again, this will be an important document for you to interact with and provide
comments.
There are other important initiatives that the SARB has undertaken in the past year, in
relation to financial markets, many of which were in collaboration with you as market
participants, such as the launch of South African Foreign Exchange Committee
(SAFXC).
The SAFXC will be member of the Global Foreign Exchange Committee, the body that
has been tasked with the ongoing maintenance of the FX Global Code and ensuring
continuing collaboration between central banks and the private sector on developing
principles for good governance in the foreign exchange market2. The SARB has
previously announced that as from 01 September 2018 it will only transact with
counterparties in the foreign exchange market that have committed to adhering to the
FX Global Code.
FMD's
Some of the other initiatives are contained in newsletter, the FMD Update,
copies of which are both available here tonight as well as on the SARB website3.
Conclusion
Allow me now to conclude by saying that we have come through another busy and
challenging year, characterised by high levels of volatility and uncertainly in our
markets. The collaboration between the SARB and financial market participants
continued in a constructive atmosphere and ensured the orderly functioning of our
markets in the wake of these challenges. Our collaboration extends to many of you
being our partners in our monetary policy implementation activities, government debt
operations, sharing of market information and analyses, as well as participation in
various market forums. We look forward to our continued cooperation so as to
enhance the effectiveness, integrity and resilience of our financial markets.
Let me take this opportunity to thank our financial markets team, under the leadership
of Mr Leon Myburgh, for their hard work and dedication to the work of the Bank during
the past year. Many projects had to be managed simultaneously while keeping the
day-to-day operations running smoothly.
I should also mention that Mr Callie Hugo will be going on retirement later this year,
and that this will be his last attendance of the annual cocktail function in his current
capacity.
I believe that I can speak for all of us in conveying our gratitude to Callie for the great
work he has done over many years in contributing to the development of our financial
markets, and being one of the key links between the SARB and financial market
participants. Even if somewhat pre-mature, because you are still around and have
some work to do, we wish you all the best for the future, Callie.
Last but not least, a very special thank you must also go to Ms Sharlay Madalane,
from the SARB protocol section for her assistance in organising this event.
Ladies and gentlemen, please enjoy the rest of the evening.
Thank you.