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Wild action in US 10-year treasuries in February/March

.Wikus Furstenberg – Head: Interest Rate Process, Futuregrowth.

SIMON BROWN: I’m chatting now with Wikus Furstenberg, head of interest rate process at Futuregrowth. Wikus, appreciate your time. In a note that came out from Futuregrowth with yourself and colleagues just last week, we saw wild action in the US 10-year treasuries in February/March. Typically treasuries are – no disrespect – slow and stodgy. And it was really a little bit crazy: largely worries about inflation, a positive economic outlook, and some fairly significant moves happening.

WIKUS FURSTENBERG: Good morning, Simon. Yes, indeed. It’s one of those things. When you look at our own fair value estimates, they’ve always stuck to sort of levels around 2% for the US 10-year. And until recently, before the sell-off, it went as low as 0.5%. It’s one of those things. We all know something needs to give, and we are all waiting for that something, and then there are one or two big players that start … it serves as a catalyst for a move, and then suddenly the wall breaks. And I think that’s typically one of those things, what we would call a mini “taper tantrum”, you’ve probably heard of that.

And way back, was it in 2013, when [former US Fed chair Ben] Bernanke indicated that they’re going to start normalising policy in the United States, then that sort of led to a global search in yields. And we’ve seen some of that in the US and elsewhere as well, and obviously, it filtered through to South Africa. 

So in a way, it’s not a surprise. The timing tends to be a surprise, but I think the local market in a way probably overreacted to that, especially at the front end, because yes, we all know inflation in the United States, elsewhere and in South Africa … is going to spike in SA in two months’ time and in the US we are going to see data today. But this because of a low base that was created last year by that collapse in the oil price and obviously a few other things as well. 

So in a way the market knows it, but the market also doesn’t know it, and then the market tends to reposition and it happens in sort of a flash. And I think that’s typically what was happening in quarter one as well. 

SIMON BROWN: And I take your point. It was a bit of a temper tantrum. It was a bit of a spectacular [thing] to watch. You mentioned that inflation. As you say, it’s a low base, particularly the fuel price. Brent was, what, in the teens. Your West Texas [West Texas Intermediate Crude oil price] for a moment there went negative. We kind of know it’s coming – and it’s not structural inflation in a sense. It’s fuel. We can see it, it shouldn’t be surprising or spooking the market.

WIKUS FURSTENBERG: That’s the thing. And that’s what central banks are trying to do. [Federal Reserve chair Jerome] Powell and *** they try their best to just sort of keep the market in the loop in terms of “this is the way we look at things. Yes, we can also get it wrong.” Never forget the fact that they’re also looking at forecasts and we know that the United States wants to have inflation higher, closer to the 2% level. 

For instance, today we should focus on core. Today, headline CPI in the United States is going to spike to, say, 2.5%, but the core is going to hover somewhere around 1%, 1.5%. I think that’s what we need to focus on. 

Locally the governor of the South African Reserve Bank also made it very clear that “Guys, we all expect this. We all expect the year-on-year rate to go as high as 4.5% or so.” But what we tend to do is we focus on post this adjustment, in a way normalisation of the rate. And do we expect SA inflation to head to the bad old days where we saw it at 5%, 6%? And at this point, Simon, we do not expect that.

We expect inflation to hover somewhere between 4%, 4.5% post the jump that we are going to see with I think the main number.

I think that’s the focus; that should be the focus. It’s a relative price change and its base effects, and how much of that will lead to proper ugly inflation? How much of that pass-through will take place for the end consumer?

SIMON BROWN: Yes. And 4%, 4.5%, that’s smack-bang in the Reserve Bank’s target range, which then brings the point – our local market seems to be pricing in fairly aggressive rate increases later in the year. The data that you’re suggesting for our inflation is in the mid of that zone. I’m not sure we’ll get rate increases necessarily this year at all.

WIKUS FURSTENBERG: No, I tend to agree. I think the forward rate agreement market, the market you refer to, is certainly very aggressive. But the market tends to also reflect tantrums. It sees direction and then it starts pricing it and then it overreacts, and we disagree with the extent of the policy tightening that that forward market is pricing at the moment. And obviously, we will take positions against that as well if we feel strongly about that. I just think that it’s overly reactive, overly aggressive. 

And I think in a way, yes, we are going to see growth picking up significantly, even if you sort of go to a very bullish number of 5% for this year. Remember, last year we were still down 7% and inflation isn’t that much of an issue. So the central bank has got scope to sort of just keep the foot off the pedal for now. Why be aggressive if underlying inflation is not going to be the big issue?

SIMON BROWN: The key point here: underlying inflation. It’s that core inflation, focus on that number. 

Wikus Furstenberg,  head of interest rate process at Futuregrowth. I appreciate your early morning.

Listen to Tuesday’s full MoneywebNOW podcast here

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