SA banks put global counterparts to shame, again

The South African banking sector seems insulated from the fallout taking place on the international banking stage, for now. Yes, bank share prices ‘blipped’ lower following the collapse of US-based Signature Bank and Silicon Valley Bank (SVB); and, of course, local investors fidgeted nervously following the emergency ‘swallowing’ of Credit Suisse by UBS; but overall, your clients have little to fear. Economic growth, interest rates and the potential for another round of global financial contagion were among the topics covered during a recent investment webinar by global asset manager, Ninety One.

What just happened?

Peter Kent, Co-Head of SA & Africa Fixed Income was first up to the virtual podium as he set out to answer ‘what just happened, from a bond market perspective’. “One of the key features of this [interest rate] cycle versus previous cycles is the speed at which everything has evolved,” Kent said, before detailing how the market and analyst’s expectations for interest rate moves had shifted over the first quarter of 2023. 

Entering 2023, the asset manager felt that the global outlook was improving whereas the domestic outlook was deteriorating. South Africa’s woes are well-documented and include Eskom and further fiscal erosion in the run-up to the 2024 elections. “The peak pricing of US interest rates, or the Federal funds rate, was one of the key reason why the global outlook had started to stabilise,” he said. The re-pricing of this rate had started to plateau around October / November last year. Unfortunately, the stability of the Federal fund rate at around about 5% was short-lived, with various data releases affecting volatility in January and February 2023. 

Further interest rate hikes were factored in based on US jobs data in January; the January inflation ‘print’; and more recently, mutterings by the Federal Reserve chair, Jerome Powell, that a 50-basis point hike was “on the table”. This comment caused the US market to rerate its Fed funds rate peak outlook to closer to 6%, reintroducing volatility to the measure. “We had not seen those kinds of levels since the 1990s, so that was a breath-taking level for rates to get to,” said Kent. Somewhat counterintuitively, the SVB collapse resulted in the market reforecasting interest rates lower. Market expectations of the Federal funds rate moved over 100 basis points in a couple of days, exhibiting more volatility than during the global financial crisis. 

Round II of a GFC unlikely

But why did SVB collapse in the first place? Kent took a few minutes to explain: SVB had attracted quite a lot of deposits from the tech sector; but since the sector has been under pressure for the last six- to 12-months, these companies were drawing down on their cash reserves. SVB and other banks had accepted these deposits when interest rates were much lower and invested them in longer-dated bonds and mortgages. “Those longer-dated instruments rerated as the Federal Reserve hiked rates, with the result the assets side of banks’ books were getting eroded,” he said. The fact that depositors at SVB were withdrawing deposits coupled with the speed of ‘bad news’ over social media contributed to a swift run on the bank. 

Analysts are confident that the SVB hiccup will not lead to another GFC-style meltdown, thanks to the various tools central banks have to control liquidity in financial markets. “During the GFC there was a scramble for dollars across the globe … [this time around] it was more of a problem of deposits being ‘run’ out of the bank,” Kent said. The US government responded by guaranteeing depositors’ funds and ring-fencing the problem. But Credit Suisse, which was described as a risk-related matter, caused further disruption. The combination of the SVB and the Swiss bank’s buyout by UBS sent market expectations for the peak Federal funds rate from close to 6% to around 4.5% in a matter of days. 

Rate volatility a key influencer of asset prices

According to Kent, the price volatility on the Federal funds rate is a key input to asset price discounting. “Volatility is unnerving; and since rates volatility is higher than equity volatility, financial markets are a trifle nervous”, he said. Although the problem is being managed as a bank-specific crisis it is likely that it will spill over into the broader economy due to constrained growth on the back of lower credit extension. Barring another macroeconomic shock, these concerns should filter through financial markets over the next three- to six-months. 

Enough of this global bluster, what about the impact of Swiss- and US-based banking crises on South African consumers and / or investors? One of the ways to assess a global event’s impact on South Africa is to track the currency. It turns out the rand has traded through yet another disappointing period versus the US dollar. Since peaking in November 2022, the rand has underperformed relative to other emerging market currencies by about 10%. So, we are sitting at R18.10 to the US dollar instead of around R16.50 to R17.00. The rand’s underperformance has not been driven by the latest banking concerns but by local factors. For example, the rand came under pressure in December last year as the Phala Phala report made headlines and again through January and February 2023 as the magnitude of the loadshedding crisis became clearer. 

Perennial underperformer, rand versus US dollar

The rand has found some unexpected support from a weaker US dollar. Kent then turned to the question of what the rand versus US dollar outlook meant for diversified income funds, which used the rand as a hedge against offshore bond positions. “The rand’s underperformance has been a very good hedge; as a result, we have been increasing our offshore allocation over the last month or two,” he said. As for interest rates, the South African Reserve Bank (SARB) still seems to be inching towards the top of its hiking cycle. Ninety One still expects local interest rates to peak below 8% thanks to the domestic inflation picture being way more benign than in the US. Kent noted that local inflation was in a much better place compared to the US, meaning we do not need to price in much more in terms of interest rates. PS, this presentation was prior the ‘shock’ 50bp hike, 30 March. 

To conclude, Kent shared some of the diversified income fund’s positioning towards end-March 2023. First and foremost, he reminded the audience of independent financial advisers (IFAs) that the fund was yielding almost 10% thanks to its number one line of defence; income. “We earn a decent amount of income just through the passage of time … there is plenty of income on the table and it is yielding close to 9.8%,” he said. “Thanks to peaking inflation and the improving SARB outlook, the fund has been able to increase duration to just over 1.5 years. “Our foreign exchange exposure is our second line of defence against capital drawdowns [and] that has oscillated anywhere between 5% and 8% over the last couple of months as we look to protect the fund,” he concluded. Concerns over a global recession in the second half of the year mean that the rand is likely to remain a decent hedge for the asset manager’s bond position. Final word: income is its first buffer, but the sweet spot remains in the front end of the curve. 

Writer’s thoughts:

I must confess to having been a trifle nervous about recent global banking sector news, but the asset manager succeeded in shifting my concerns to the margins. I guess the bigger concern entering Q2 2023 is what happens to financial markets if / when recession hits. Are you concerned that recession could decimate financial markets and investment returns in the second half of this year? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected].

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