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Sarb steps into the bond market

But is it really quantitative easing, or isn’t it?
However you define it, the move is seen as an exercise in financial stability. Image: Moneyweb

On Wednesday morning the South African Reserve Bank (Sarb) announced that it would start to buy government bonds. This is a tactic, known as quantitative easing (QE), that has been used by central banks in the US, Europe and Japan for some time to stimulate their economies.

Read: Sarb starts buying bonds to inject emergency cash

Until now, however, the Sarb has been reluctant to do this, even in the face of political pressure. ANC Secretary-General Ace Magashule infamously suggested last year that QE should be explored “to make funds available for developmental purposes”.

The Reserve Bank’s decision could therefore appear to be a significant departure from its traditionally conservative stance.

Read: ANC targets broader central bank mandate after GDP shocker

The bigger picture

However, analysts believe it is important to see the Sarb’s move in context. Significantly, it follows last week’s decision by the bank to introduce additional measures to support liquidity in the bond and money markets.

Essentially, the commercial banks did not have, or were not willing to use, the cash necessary to sustain the normal functioning of the bond market. As the primary buyers of government bonds, they play a crucial role in supporting transactions.

“The Sarb realised that there is a liquidity crunch, so it allowed banks to borrow from it at a reduced rate,” explains Ryan van Breda, portfolio manager at Ngwedi Investment Managers. “That was to support money market liquidity.”

These steps alone, however, did not have the desired impact. Bond yields continued to rise, with the yield on 10-year government bonds going as high as 12.35% on Tuesday.

Making moves

“It’s important to understand that what we’ve seen in financial markets over the last two to three weeks is a liquidity event, not a valuation event,” explains Ian Scott, head of fixed income at Momentum Investments. “So for the South African bond market and the money market, it is far more important that the Sarb injected liquidity than just cut the repo rate. Not that the cut wasn’t the right thing to do, but for the market, liquidity is more important.”

It seems therefore that the Reserve Bank has felt compelled to go a step further and become a participant in the bond market itself.

“The Sarb is saying that the banks don’t have to be the only buyer of bonds,” explains Jonathan Myerson, head of fixed income at Visio Capital. “It will be the buyer of last resort.”

The market reaction was immediately positive. Yields on 10-year government bonds fell for the first time since March 10, retreating to 10.69%.

Where this leads

However, investors are still concerned about what QE could mean for the country. Where central banks have been buying government bonds in developed economies, their intention is to allow the state to expand its spending.

South Africa can hardly afford to do this. Government finances are already stretched, and expectations are that the budget deficit could balloon to as much as 10% of GDP as the economy contracts due to the impacts of Covid-19.

The Sarb’s intention, however, appears to be different. Its objective is not to support additional government spending, but to ensure that the bond market doesn’t freeze up.

“The purchasing of long-term bonds is effectively QE,” explains JP du Plessis, portfolio manager at Laurium Capital. “But this is not necessarily about pumping endless amounts of rands into the system. It is to support the functioning of the government bond market.”

Myerson agrees.

“The first intention is to ensure there is sufficient liquidity and the market doesn’t become dysfunctional, because ultimately National Treasury needs to be able to keep issuing bonds,” he says. “It is important to allow the government to continue borrowing at the rate it was before.”

The context

There are three important factors to consider in this regard. The first is that the Sarb did not specifically state how much it intends to spend on buying bonds. It may, therefore, be a fairly nominal intervention.

“The point here is that they can do a lot by just saying they are going to do it,” says Du Plessis.

“Just the threat could be enough, and certainly it was if you look at how the market reacted.”

Secondly, the Sarb does not want to sit with government bonds on its balance sheet.

“There is no doubt that the size of buying is limited,” Myerson says. “Whatever they buy they are going to have to sell back into the market because they are not going to be able to sit with a balance sheet of government bonds that are very volatile.”

Finally, the Reserve Bank still has a lot of room to move in terms of its primary monetary policy tool, which is the interest rate. Even after dropping the repo rate by 1% last week, it is still at 5.25%. This is high by global standards.

Read: SA’s biggest rate cut in more than a decade in charts

If the Sarb’s intention is to stimulate the economy, it can therefore still drop that a lot further. It is not in the same situation as central banks in developed countries where interest rates are at or near zero, and so QE is the only other option they have.

“I would say that the Sarb injecting liquidity is not entirely QE,” says Van Breda. “What they are exercising here is financial stability.”

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What have the “big banks” done to assist the citizens of South Africa of their own free will during this crisis. Yet they run bleating to the reserve bank for special treatment, in the meantime how much of their lending risk has actually been secured offshore a long time ago and how much of their borrowings are actually done through SARB vs offshore. I cannot believe that with international interest rates of 1 to 0 percent they would borrow locally at 5 and above. Have you ever wondered why banks only ever make a “provision” for bad debts and never actually report back on how much of that “provision” was actually consumed, this is a technique called “smoothing” which is deferment of taxes.

Sarb’s balance sheet is expanding quicker than covid19

Quantitative Easing at a REPO rate of just over 5% is a misguided and futile act. South African banks are not in meltdown… Business and consumers are the ones in dire straits. REPO rate should be dropped to zero and that will lead to prime falling to 3% then SARB can buy the bonds and securities. Business will borrow more, create employment and people will have income and buy more to revive the economy. The approach of the SARB is helping banks that don’t need the money. Business wont borrow becomes prime is still 3% above REPO.

Spot on. Our high interest rates act as a deflation magnet. Local businesses cannot compete internationally when their cost of capital is at least 100% more expensive. The high interest rate imports deflation and financial contraction and unemployment to South Africa. Business models that would have failed in Europe, are now failing in South Africa, due to the difference in the cost of capital.

and what if the rate cuts didn’t provide the liquidity that the market needed to function? Why would you suggest cutting rates further when it wasn’t fixing the problem the SARB wanted to fix?

Could unleash the inflation dragon like rest of Africa. Reserve bank mandate is price stability.

Gov could set up a separate bank for Covid crisis loans at lower rates. It’s an option

Mandate is price stability indeed. If markets aren’t working and demand has fallen off a cliff, I don’t see prices being very stable. As for inflation rocketing, maybe, but worth the risk to have functioning markets. Otherwise our economy won’t function anyway

No matter how Mr. Cairns wants to explain it away, if it quacks like a duck it aint nothing else but a duck. This is QE and noting else. And its not aimed at bailing out you and me rest assured. Its bailing out the fat cats who have been merrily gambling away at the casinos that goes by the pseudonym “financial markets”. When The ordinary Joe Soap is done dealing with the Corona virus he/she will be faced with a far worse and more destructive pandemic called hyper inflation caused by this new “money out of thin air” SARB will be pumping into the economy to keep the greedy going instead of allowing them to perish so that a healthy economy can rise again in the aftermath of Corona. That’s what recessions was all about pre 1987

Assuming liquidity was a real issue (which by all accounts it was), then this was much needed. I’m sure the SARB is genuinely intending this to be temporary, just as the FED and ECB did in 2008. We’ll see how big that balance sheet is in 2025…

As part of their preparation of the response to the global covid-19 infection, the government should have consulted free-market economists and not only virologists and medical specialists. This over the top and drastic measures will merely change the medical problem into a socio-economic one. Maybe the hospitals won’t be overrun, but the fiscus will be overrun. They merely changed a “run on the hospitals” into a run on the banks. This is reckless, to say the least.

I would say we need Credit Easing as well. This thing that they are doing in no way will it contribute to overall economic growth and development at this opportunistic moment.

By advising these lockdown strategies to governments worldwide, the WHO is following the example of Nongqawuse and the Xhosa cattle-killing that caused widespread famine in that community. The WHO changed a short-term health problem into a long term economic catastrophe.

Tedros needs to be put on trial when this is all over.

As usual in these comments everyone is worried about the effect on Borrowing : What about the poor sods whos money it is that the banks are lending to others : They should expect others to use their money virtually free of charge whilst their income is reduced ??
The Bank simply takes a margin and benefits from both !

A great lesson SARB still has to learn. If rates are going to low, investors are all going to shift to other asset classes and won’t be buying bonds anymore let alone leaving cash in low return money market investments. This is going to create massive funding issues for government and they know that. The reason why they want to force “prescribed assets” onto pension funds.

I think the ANC should be less concerned about financial markets and more concerned about helping people on the ground level to buy food and survive the lockdown period. We are not a first world country and many people are going to starve and also their dependent families in other parts of Africa.

I hope the cure (lockdown in SA) is not worst that the disease for the really poor in this country.

Let’s not even go to potential risk factor of social unrest because of an unsustainable situation for many.

End of comments.

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