I got my flu inoculation this past week. An innocent jab in the upper left and that is it for the year. Wonderful invention for those over 50.
Likewise, the SARB (South African Reserve Bank) has started giving us its anti-Yellen inoculation. Only it isn’t an innocent jab in the upper left arm, but a few vicious punches where it hurts. The first one was given last January, and there are 12-15 more months to go to showtime with Yellen.
It is called strategic preparation for what’s coming. And what’s coming isn’t funny.
That said, SARB is the first one to admit, in public without qualifications, that it isn’t quite clear what exactly it is that’s coming, aside of Yellen at some point raising US rates from zero now to somewhere else next.
That’s the truth. And we better be ready for it.
For if you aren’t, markets have a way of weighing you, especially available returns and perceived risk. And if found too light-weight, they tend to sell you.
Such anti-social behaviour can have all kinds of consequences having a direct bearing on the SARB’s main mandate, namely containing inflation 3-by-6.
If that sounds like a fish cake, or the dimensions of a grave, or the bullseye of a roving eye in the sky, that is entirely coincidental and unintended.
The presumption is that, like last year in preparation for QE tapering, once the Fed starts to raise rates, global risk/return configurations will adjust, too.
And if you don’t come fully prepared to that pyjama party, you may end up fully stripped. That means much weaker Rand, higher inflation and expectations, more risk, more disrupted than ever.
Whereas stability, lower risk, lower premiums, lower inflation, lower interest rates, better growth is really what we want.
Interestingly, this is the One-and-Only scenario SARB is prepared to publicly consider and is not so quietly preparing us to face, even if the timing will be totally opportunistic.
For the Feds don’t know when they will move, how fast and to what end destination, except vague promises of slow and higher, designated by dots, and these a moving feast between meetings.
And SARB has no way of knowing how markets will respond, at what speed, except being nearly certain they will move.
It sounds like a situation that if you wait too long to see what happens, the trigger happy will overwhelm you. So better be an early mover, prepare the new trenches 500 miles behind the front, make a strategic withdrawal during the night, and when the terrifying moment comes, be happily ensconsed in new defences, ready to give battle.
So how much is this supposed too cost us?
Well, not too much for the economy is still on its face, and various unions and state enterprises are working overtime to keep it there. And that’s bad.
Also, we don’t really know how gentle or horrible Yellen will get, or for that matter how demanding and grasping markets will get.
What will be the minimum we can get away with, plus a comfort buffer?
This sounds remarkably like a scenario with many subplots. My money is on the US expansion remaining very steady, the resource uptake to be very modest, for inflation to keep undershooting, and for the Fed to only very gradually lift its rates during 2015-2017, and possibly not so high (half) as what tradition would by now be demanding.
We don’t really know exactly where the Americans are heading or their speed and the same is true for us, with risk premium complications to booth. It makes SARB very cautious but not overhasty.
So no rate increase before an election but a slam dunk reality immediate after one? Fair enough. That gets us 1% cumulative off the floor, but the repo rate at 6% still only neutral in real terms. That’s not much of a strategic fallback position or buffer.
If FedFunds is on its way to 3% (+1 or +2% in real terms, depending on US inflation), by say 2018, how much more EM premium are we supposed to add?
Could we get away with an extra +1% or is that too little? Bearing in mind our poor economy shows no signs of acceleration and only a strong presence of severe intimidation, the kind that keeps business confidence troubled and focused on growth activities elsewhere.
Anyway, we have done only +0.5% so far, with prime now 9%. In surfing terms, you may want to stay ahead just off the building wave crest in order to ride it. So perhaps another hike here and another one there to keep market tone healthy ahead of the Fed start in 2015, with us hiking overall 3%-4% by 2018, giving us prime 12-13%.
But the problem with one-horse towns is that all bets are off when another stallion walks in. His name could be Putin, he has in fact been sighted, he might catch Europe and the ECB completely off guard with off-the-wall behaviour unacceptable to America that may lead to complications having the effect of depressing European growth and inflation and cause ECB president Draghi to do a Bernanke 2009.
That could cause severe turbulence and cross-currents in global markets very much at variance with the Fed intention (and in fact inviting her to stand down and delay?).
In which case our Rand could even firm beyond expectations and our rates might have to be cut, quite different from the One-and-Only view we are being force-fed daily.
That makes the whole timing thing even more opportunistic.
Do not, therefore, assume to have the final answer even if the markets offer you a price. What certainty is there they are pricing right as to actually pricing the future wrong with so many unknowns clouding the outlook?
But that won’t prevent anyone laying bets. It certainly will be the horse race of the decade, especially if the European mare gets in on the act, too. And if she proves to be on heat, the fat will really be in the fire.
Issued by Cees Bruggemans – http://www.bruggemans.co.za/
