Daniel Mminele: Recent major developments in global and domestic
markets
Address by Mr Daniel Mminele, Deputy Governor of the South African Reserve Bank, at the
Financial Markets Department's Annual Cocktail Function, Pretoria, 24 June 2014.
* * *
Good evening,
It is a great pleasure for me to welcome you all to the Financial Markets Department's Annual
Cocktail function. As has become tradition for this event, we would like to take stock of the
major developments in global and domestic financial markets over the past year, before
updating you on matters relating to the Financial Markets Department and initiatives
undertaken over the past year. Tonight we will adopt a different approach, namely that I will
cover the first section, and then hand over to Leon Myburgh, Head of the Financial Markets
Department, to update you on departmental activities.
Given recent releases of the Monetary Policy Review, the Quarterly Bulletin and speeches, I
shall not comment in any detail on recent economic developments.
Re-pricing of risks in international and local financial markets
Those of you who were able to attend our function last year will recall that the assessment at
the time was that of increasing confidence about the gradual "healing" of the global economy
and financial system, and the reduction in "tail risks" that had unsettled markets for the
previous two years. These improvements were at the time largely attributable to the drastic
policy actions undertaken on an on-going basis by the world's major central banks. Yet at the
same time, it was already becoming evident that there was a build-up of risks, and that the
impact on financial markets of the timing, as well as the pace, of the eventual and
unavoidable reversal of these extraordinary measures, could be substantial.
Looking back over the past twelve months, these factors became the dominant drivers of
market movements, as was anticipated at the time. The gradual improvement in the major
economies that was expected a year ago has continued, by and large, to materialise. Global
economic growth has picked up, albeit unevenly. The underlying strength of the recovery has
been confirmed in the United States, the Euro zone has emerged from recession, and there
are indications that a prolonged period of deflation could be ending in Japan. The extent of
the slowdown in emerging market economies appears to have been one of the main surprise
developments over the last year as emerging markets were not spared the negative
consequences of global risk realignment while expectations of lesser liquidity provision by
the US Federal Reserve led to increasing differentiation by investors across
emergingmarket assets. As you know, currencies and bonds of those countries experiencing relatively
wide current account deficits, sluggish economic expansion and inflationary pressures
underperformed assets of emerging markets who performed better on these metrics. Concerns
about a deceleration in Chinese economic growth also affected financial assets in
commodity-exporting countries, like South Africa, which had benefitted from China's surging
industrial demand in earlier years.
While the global economic recovery remains broadly on track, high levels of uncertainty,
vulnerabilities and fragilities remain, and the global growth outlook continues to harbour
downside risks, as the first quarter of 2014 has shown.
As indicated above, global financial markets developments have been mainly driven by
changing expectations around asset purchase tapering by the Fed and the eventual
normalisation in US policy rates. Consequently, the latter part of 2013 saw long-term bond
yields increase in all major developed and emerging economies, and yield curves steepened
as investors required a higher "term premium" across a broad range of fixed-income assets,
while currencies of emerging market countries at times adjusted abruptly and sharply,
leading to a general tightening of financing conditions.
More recently we have observed an easing of financing conditions, based on expectations
that monetary policy in the US will only adjust gradually. These developments are
underpinned by improved communication by major central banks and further policy
measures such as the ones recently announced by the ECB. This has resulted in increased
risk taking in financial markets and made carry trades more attractive given reduced levels of
volatility. Emerging markets have been benefiting from these developments by way of better
performance of their currencies and capital inflows.
Unfortunately, the increased risk taking in financial markets is not matched by increased risk
taking in the real sector of the economy. In addition concerns are emerging that the
extraordinarily low levels of volatility (e.g. the VIX index is below pre-crisis levels) may be
providing incentives to misprice risk and thus increase financial stability risks. A further
hazard going forward is the increasing divergence in monetary policy in advanced
economies, with the US Fed and the Bank of England moving towards lifting policy rates as
part of normalisation, when on the other hand the ECB and Bank of Japan are expected to
ease monetary conditions further.
Thus the current situation in global financial markets does not allow for complacency and
requires policy makers and market participants to remain alert and carefully manage risks.
Domestic markets within the global context
Given the high level of integration with international financial markets, domestic financial
market developments reflected these developments, but were also significantly influenced by
South Africa intrinsic factors. The under-performance of the rand relative to other
emergingmarket currencies was particularly noticeable over three specific periods. The first one
occurred in May and June 2013, when the Federal Reserve first talked of "tapering" its
Quantitative Easing programme. The second one, in August 2013, coincided with a rise in
risk aversion towards countries with large current-account deficits and deteriorating growth
fundamentals. In the third phase, from mid-December to late January this year, in addition,
investors appeared to be differentiating against countries that were seen to have been slow
in their policy responses to tapering and normalisation risks. This period was characterised
by significant net sales of domestic securities held by non-resident investors. Of course it
was not only global developments that influenced local markets, as on-going labour market
disruptions added to negative sentiment, underperformance in the real economy, and a
worsening Balance of Payments situation.
As mentioned earlier, the last few months have brought some signs of greater stability to
both global and domestic financial markets: The rand has recovered since its late January
trough; the yield on the R186 benchmark government bond has declined by 64 basis points;
and the JSE‟s All-Share Index has climbed to new highs, gaining 10.4 per cent on a
year-todate basis, and net non-resident flows into the local currency bond market stabilised in
February to April, before posting a net positive inflow of R10,6 billion in May and R8,2 billion
for June (until 23 June).
The levels of development, sophistication and depth of our financial markets have allowed
South Africa to weather the turbulence of the past year reasonably well. However, we have
to acknowledge that there are still some risks in the system, even if they are difficult to
quantify. Bond yields are low relative to the averages of the past decade, and the
nonresident share of government bond holdings remains very high by historical standards. Carry
trade activity, which seemed to support the domestic bond market in May, is by its own
nature a temporary phenomenon, even though its timing is unpredictable. These factors
suggest that local yields could be vulnerable to risks of a renewed global bond selloff or a
sudden spurt in risk aversion. By several metrics, finally, South African equities appear
increasingly expensive.
But it is important to accept that the transition period on the path of policy normalisation will
not always be smooth, and not to confuse the bouts of volatility that we have experienced,
and which are likely to be with us for a while, with instability in our markets.
Monetary policy challenges
Monetary policy in South Africa is currently facing an increasingly challenging situation, as
the domestic economic growth outlook has deteriorated markedly even as inflation broke out
of its target range. This deterioration is heavily influenced by supply side factors and final
domestic demand has slowed in recent quarters, indicating a continued lack of
demanddriven price pressures in the economy. This suggests that the current rate cycle need not
match the speed and magnitude of earlier cycles. As you are aware, we entered the present
rate hiking cycle in January this year when the repo rate was increased by 50 basis points to
5.5 per cent per annum in reaction to a deteriorating inflation profile, with the Bank's inflation
forecast suggesting that the upper band of the inflation target would be exceeded for an
extended period. The most recent CPI print at 6.6 per cent came out above expectations,
which followed recent consumer and producer price data releases signalling a growing
passthrough of previous rand depreciation to prices of durable and semi-durable goods.
Such a risky environment continues to call for vigilance by the Monetary Policy Committee, to
ensure that any pass-through of previous rand depreciation to inflation does not become
permanent, that inflation expectations do not become unanchored from current levels, but in
fact improve as they are uncomfortably close to the upper range of the inflation target. As
indicated by the Monetary Policy Committee, the current rate hiking cycle will need to be
responsive to incoming data and information in relation to, among other factors, exchange
rate developments, food price developments, labour market data and Balance of Payments
dynamics. But the fact remains that inflation is uncomfortably high, and that risks continue to
be tilted to the upside, and that interest rates will have to normalise in due course.
In this complex environment communicating with the financial markets, which provide an
important link in the transmission of monetary policy, becomes particularly important. Central
banks implement monetary policy decisions mainly by transacting in the financial markets.
While the past year has clearly shown the benefits of an improved level of central bank
communication about likely future action, it also needs to be recognised that while policy
makers in certain instances may have more data at their disposal than market participants,
the information available is by no means perfect or conclusive enough to allow an analysis
that could result in undertakings or even promises of future action. It is also important for
market participants to realise that while feedback mechanisms between the market and
policy makers are invaluable, central banks will always be careful not to allocate a
disproportionate weight to market information that may be embedded in market prices such
as FRA rates, and will always cross-check with other information and relevant economic
variables. While at times policy makers may feel the need to correct certain impressions that
may exist and are influencing market prices at particular times, or give appropriate guidance,
it should not be expected of policy makers to keep commenting directly on short-run market
movements, as has been suggested by some. „Running commentary‟ in this regard could
unnecessarily add to volatility.
Concluding remarks
Let me conclude by once again thanking you for attending our event today, and also thank
you for the cooperation we have enjoyed with you over the past year as both policy makers
and market participants were navigating choppy waters within an increasingly complex
environment. Our consultative structure in the form of the Financial Markets Liaison Group
(FMLG) has matured, and I would like to thank many of you present today, who participate in
the various sub-committees of the FMLG and provide us with valuable inputs to inform our
work here at the central bank. The FMLG will continue to play an important role as we further
develop our markets and ensure their efficiency, transparency and integrity. In this regard,
we also continue to monitor global investigations around reference rates. Furthermore, we
have noted with concern the recent reports from abroad regarding the investigations around
alleged foreign exchange manipulations. We will continue to monitor and consult
developments in this regard and consult when necessary to ensure that practices in our
financial markets continue to be characterised by appropriate levels of transparency and
integrity.
Let me now hand over to Leon Myburgh to share with you initiatives that the Financial
Markets Department has been busy with.
Thank you.