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.
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.
“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.”