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Sarb: This is not quantitative easing

But the risks can’t be ignored
Image: Dean Hutton/Bloomberg

The South African Reserve Bank’s (Sarb) announcement on Wednesday that it would start buying government bonds brought immediate relief to the bond market. Yields on the 10-year government bond had shot up from 9.22% on 10 March to 12.36% on the day before the Sarb stepped in.

Yields have however since retreated to around 11.60%. Bid-offer spreads have also narrowed to normal levels after blowing out to as much as 100 basis points at the height of the liquidity crunch.

Read: Sarb steps into the bond market

Broadly, market watchers welcomed the bank’s intervention, which had become necessary to stabilise a market that was suffering from a severe lack of liquidity.

Industry support

“We had a situation where the global dislocation was feeding into SA and it was causing major dislocations in the SA market that potentially could have caused other catastrophic events,” explains Nolan Wapenaar, head of fixed income at Anchor Capital. “The Sarb has put in a pin in the risks, and right now things are functioning again. So I think it has been very successful.”

It’s also worth noting that the Sarb’s actions were not taken unilaterally. It stepped in after consulting with local investors and other stakeholders.

“The bond fraternity, including asset managers and banks, have welcomed the SARB’s moves to help normalise market conditions and prevent disorderly trading conditions, funding spreads and dislocations,” points out Albert Botha, head of fixed income portfolio management at Ashburton Investments.

“The Sarb communicated that it intends to continue to act and implement its expanded announced liquidity management strategy until it is satisfied that liquidity conditions in the local funding markets have normalised.”

The QE question

Stabilising the market by buying government bonds does not, however, come without risks. As many analysts point out, this is akin to quantitative easing (QE), which is generally a way to allow for more government spending. This is hardly something SA’s already precarious finances can afford.

The Sarb itself has tried to emphasise that this is not its aim. In a note to the market, it argued that its actions are not, in fact, quantitative easing at all.

“Quantitative easing is generally applied where interest rates are zero or close to zero, and inflation is far below the central bank’s target or even threatening to turn negative,” the Sarb points out. “In advanced economies where interest rates are at or close to zero, quantitative easing has been implemented through the purchase of a range of assets to support growth and investment. In general, these countries have used quantitative easing to raise the level of inflation.

“The Sarb is not seeking to do this,” it adds.

“South Africa does not have interest rates at or close to zero and the Sarb is therefore not using this tool as a means to stimulate demand. The Sarb’s intervention is a financial market tool aimed at injecting liquidity into the market and ensuring a smoothly functioning market, rather than for economic stimulus purposes.”

What do they say about good intentions?

However, the Sarb’s intentions are not necessarily the most important factor in how this plays out.

“Unfortunately when you tinker with the operation of financial markets, there are always consequence to your actions,” says Wapenaar. “And those consequences aren’t always great.”

The first, direct consequence is that the Sarb has now effectively guaranteed liquidity in South African government bonds. This may act as a lure to foreign investors who are desperate for cash. Other assets may be more difficult to sell in this environment, but they now know that they can unload local bonds.

“The downside to that is that as they sell their rand assets, they have more rands that they need to convert into dollars,” says Wapenaar. “That means that the rand becomes more volatile.”

The second, potentially larger issue, is the political risk that this creates by setting a precedent.

The can of worms

“The Sarb is doing it now for market stability, but the long and the short of it is that it is buying bonds and injecting cash into the system,” notes Wapenaar. “This is QE. It is not QE to manage the shape of the yield curve, or for economic stimulus proposes. It is QE to keep the bond market alive at a time of extreme stress. But it’s still QE.”

The risk is that having done this now, the Sarb may open itself up to questions about why it doesn’t employ the same strategy for other purposes, such as trying to reduce interest rates or buying government or Eskom debt.

“Any actions to try reduce or interest rates or repay Eskom or government debt would be catastrophic for the country,” says Wapenaar. “We have now potentially opened a can of worms.

“We have found the one golden nugget in there, but there might be a temptation to dip our hand back in. The risk is that we pull out something really ugly.

“I’m sure that our current governor wouldn’t do it,” he adds. “But there are people who are saying things like Sarb should buy Eskom bonds, and we need to be careful.”

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Do something more contrarian and rather raise the rates.

It may be argued that interest rates gets close to zero because of QE and not that you need interest rates close to 0 to start to QE … anyway reserve bank almost on the right track … a further 2% interest rate cut will alleviate some of the liquidity issues

“ The Sarb has put in a pin in the risks”

for the bankers

Mary, the teacher or nurse or factory worker will benefit zero from the billions this will cost all the Mary’s of SA. We are selling the next generation.

I say stuff this. Let the real economy get in charge again. No bailouts, no market handbrakes. We live in a world where the synthetic economy of derivatives is hundreds of times the actual trade. Those synthetic market participants contribute absolutely nothing from their keyboard other than volatility.

It is called capitalism 101. CDS are fraud on capitalism. The price of a debt must reflect its risk, No insurance on the side.

Take oil. What IF only people that could receive a barrel were allowed to trade in barrels???

99.999999% of the people that actually own mortgage backed securities’ risks could not know the address of the underlying properties. Makes sense, right?

If you thought gold was expensive now in ZAR, have a look in 12 months time. In SA you will already pay 15% to 20% premium over spot for a KR.

99.9% of readers do not realise what the alternative to this action by the Reserve Bank would have looked like. If the Reserve Bank did not step in to fulfil its mandate as lender of last resort, then all liquidity in the banking system would have dried up. That implies long queues in the street of people who want to withdraw their savings or their salaries, but the bank is closed. This is the classic run on the banks.

The IMF advised all members to implement bail-in regulations. If any bank runs into trouble now, then depositors(investors, savers, salary-earners, pensioners and grant recipients) are considered to be creditors of the bank. The bank will go into business rescue and all depositors will get shares in the bankrupt bank, or cents in the rand for their “deposit” which actually is a loan to the bank.

So, if the Reserve Bank did not step in to buy bonds, then Mary the teacher or nurse would have lost her bank balance, her credit card won’t work, and all her colleagues will start a run on their banks and the same will happen to them. It will continue like that until all banks are bankrupt, or until the Reserve Banks steps in to provide liquidity.

We were on the brink of an event that would have dwarfed VBS and African Bank in comparison. When the Reserve Bank stepped in, it saved Mary the teacher or nurse. The Reserve Bank saved the man in the street from the utter chaos that results from the implosion of the entire financial system. We were that close. “On the Brink” as Henry Paulson put it.

We all hate the banks, but all of us use the banks on a daily basis.

Sensei, we know the “run of the banks” situation. We all give our money to the banks,but when everyone wants their money they will find only a fraction is really there! Scary stuff indeed. Then,to my question: what Sarb is doing will lead to inflation right? Who will be the real losers in such an event?

tievo, for as long as the deflationary forces are stronger than the inflationary forces, we won’t experience a general rise in the level of prices. In some instances, we can experience inflation and deflation at the same time. In the USA we saw inflation in the value of listed companies and real estate, while there is deflation in commodity prices as reflected in the Bloomberg Commodity Index. It depends on where the newly-printed money goes to. The banks receive it first, therefore they decide where the inflation will be. This is the Cantillon effect.

Sensei:

Sorry, have to disagree. With our Basel rules we do not have bankrupt banks. “Bail In” well explains your bias on this.

What I want it to wash out the weak parties once and for all and to set a precedent that the 2008 bailouts never communicated because it plain and simple led to a decade of asset inflation like never seen before. The billionaires at the synthetic end of the economy suffered nothing and carried on as usual.

Right now there are very many cautious investors sitting with 90% cash portfolios because we did not like what we saw. So what? The speculators get another free pass?

SEND THE MESSAGE : get a real job! We the masses are simply subsidizing twenty thousand do-nothing speculators’ extravagant lifestyles – people have never and should never run a real business!

The SARB’s role currently with the Coronavirus should be to ensure the machinery of financial markets stay well oiled and only that, nothing more.

Their role should definitely not be to “manipulate markets” and blow up the countries balance sheet.

The SARB has been there before, the temptation to manipulate the markets with the financial rand in the old days. Who can remember the massive forward book to manipulate the currency. Letsetya (the SARB Governor) will remember that well as he was a trader at Standard Bank if I remember correctly.

The forward book ended up costing the country billions of rands and it never works. The market will always be bigger than the Reserve Bank of any country.

With the currency on the 31 Dec 2019 at R14.00 to the dollar and currently at R17.65 => that is a 26% drop in currency value. That means in dollar terms we as South Africans as 26% poorer in dollar terms (everyone in this country).

The concept of a fiat currency is that the currency remains stable and holds it value.

When you start inflating your balance with debt (QE) , artificially lowering interest rates , a potential downgrade of SA to junk status and you can’t hold your currency stable. Then you are looking for serious trouble.

Perhaps that is what the ANC wants, only the politically connected person with resource shares will benefit the most. The rest of industry that relies on expensive imported capital goods will have to take their bags and go to another country.

“The concept of a fiat currency is that the currency remains stable and holds it value”. In theory yes, but in history, never. Fiat currency always leads to bubbles. We are seeing that these bubbles’ frequency spikes are narrowing at an alarming rate. I don’t want to contemplate the endgame but QE and measures like it, effectiveness will degenerate…..

Buying bonds as of Government or Eskom which is basically bankrupt will lead to the decline of our currency at a more rapid rate which will impact the poor the most. Imagine a loaf of bread at R50.

For those that like how this crony political and financial system works, the banks are for you. For everyone else gold and crypto is for you.

For those who actually wants to understand why and what the SARB did read RW Johnsons excellent piece on politicsweb

I’m not convinced. All this effectively does is provide liquidity for bond holders – 40% foreigners – ahead of the index rebalance which will result in South Africa being removed from the global bond index. Surely a high percentage of this money will find it’s way offshore.

End of comments.

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