There has been record inflows into money market and income funds over the last while as nervous investors tread water ahead of a potential downgrade and further bad news on the domestic and global front.
These inflows need to be invested into a limited pool of mainly domestic fixed income assets, at a time when very few borrowers are looking to the capital markets to raise financing. This supply/demand imbalance therefore results in a benefit to the few borrowers that are looking to raise finance, in that their cost of borrowing has been declining as a result of the excess demand for income generating assets.
In response to the excess liquidity in the market and demand for income, banks have been able to reduce deposit rates at a faster pace than the SA Reserve bank has reduced the repo rate. As the majority of the larger income funds in South Africa are heavily weighted towards negotiable deposits from the big four banks, yields on their funds have been declining in excess of the last MPC rate cut of 25 basis points. This has been further exacerbated by the fact that credit risk premia have on corporate debt has been discounted or ignored, in the feeding frenzy for yield.
Despite South African interest rates being amongst the highest of the emerging market countries, (some of which, such as Brazil, have already been downgraded), and domestic inflation under control, we do not believe that the SA Reserve Bank is in a comfortable enough position to reduce rates dramatically – especially while there is a Sword of Damocles hanging over the country’s head in the form a Moody’s downgrade and a potential sell-off of bond positions by index fund managers worldwide. Considering the issues at Eskom and the effect this will have on domestic economic growth, it now seems likely that Moody’s will downgrade South Africa shortly
Taquanta Asset Managers, Managers of the Nedgroup Investments Cash Solutions fund range