In­fla­tion bug dead

Long-term in­ter­est rates lower than short-term ones

Finweek English Edition - - Openers - VIC DE KLERK

SOUTH AFRICA cur­rently has the sharpest in­verted (or ab­nor­mal) in­ter­est rate yield curve since the nor­mal­i­sa­tion and open­ing of its money and cap­i­tal mar­kets around 30 years ago. What all that means is that, against all logic, long-term in­ter­est rates are now con­sid­er­ably lower than short-term in­ter­est rates: 30-year Gov­ern­ment bonds are cur­rently trad­ing at an in­ter­est rate of 7,42%/year, as against the 9,75% on 12month de­posits.

The phe­nom­e­non of short-term in­ter­est rates that are higher than longterm ones cur­rently oc­curs world­wide. Some­times there’s an al­most log­i­cal ex­pla­na­tion for the phe­nom­e­non in de­vel­oped economies. How­ever, in de­vel­op­ing coun­tries such as SA it sim­ply doesn’t make sense. The def­i­ni­tions of nor­mal and in­verted yield curves (see box) ex­plain why that hap­pens some­times but it’s dif­fi­cult to ap­ply the rea­sons to SA’s eco­nomic en­vi­ron­ment.

SA’s econ­omy isn’t head­ing for a re­ces­sion. That might also be the case in the US, where con­sumers have too much debt; then re­ces­sion-fol­low­ers could eas­ily rea­son that it must nec­es­sar­ily spill over to SA.

On the other hand, it would be won­der­ful if SA’s 30-year in­ter­est rates – now al­ready 2,25% lower than the one-year rate – meant that SA has fi­nally com­pletely stamped out the in­fla­tion bug. Could I dare to say, as a news­pa­per head­line once struck me on a cold morn­ing 20 years ago: “We have licked in­fla­tion”?

Some of us have grown up – even grown old, for that’s how long it’s con­tin­ued – with dou­ble-digit in­fla­tion fig­ures. That’s why it re­mains rather un­be­liev­able, for the pes­simists among us any­way, or even in­cred­i­ble.

The flight-to-qual­ity that took place in 1998, when it ap­peared that many of the emerg­ing coun­tries at the time – as well as their gov­ern­ments and busi­nesses – were no more than a flash in the pan, also hit us and SA had a so­called steep or sharp, in­verted curve, with long-term rates climb­ing to 22%.

It’s dif­fi­cult to be­lieve that it’s the flight-to-qual­ity that’s cur­rently push­ing our longterm rates down so much, which Wikipedia sug­gests is a pos­si­bil­ity.

The short­age or lack of sup­ply of new Gov­ern­ment bonds is per­haps more im­por­tant. The fis­cus isn’t go­ing to bor­row any money this year to fi­nance its ex­pen­di­ture. In fact, it’s go­ing to achieve a R9bn sur­plus, which may even have risen to R12bn, and it’s go­ing to use that to buy back

The steeper in­verted trend in in­ter­est rates shows that more bond in­vestors be­lieve there’s some or other re­gres­sive event in the off­ing.

Gov­ern­ment bonds.

In the past the fis­cus’s deficit was of­ten as much as 4% of our gross do­mes­tic prod­uct. If that were the case now, the fis­cus would have to of­fer new Gov­ern­ment bonds to the value of as much as R60bn for the next year. That would cause quite a dip in that in­verted curve.

Wikipedia points out that his­tor­i­cally yield curves on 20year US Trea­sury bonds av­er­aged ap­prox­i­mately two per­cent­age points above that of three-month Trea­sury bills.

In SA, the gap is even big­ger, though for years we had an un­nat­u­rally low long-term in­ter­est rate, due to the old in­vest­ment pre­scrip­tions that forced in­sur­ers and pen­sion funds to in­vest in cer­tain as­sets.

But what does strike me is that long-term in­ter­est rates, even though they’re con­sid­er­ably lower than short rates, are still higher than in­fla­tion in the rel­e­vant coun­tries.

The last ta­ble on our sta­tis­tics pages shows the in­verted in­ter­est rate yield curve and the in­fla­tion rate for ev­ery coun­try. Ja­pan is an ex­cep­tion, as its cur­rently still re­cov­er­ing from its pe­riod of de­fla­tion and zero in­ter­est rates.

Clearly, there’s now a clash be­tween the sen­ti­ments of in­vestors in shares and those who pre­fer fixed in­ter­est rates, such as on Gov­ern­ment bonds. The in­creas­ingly steeper in­verted trend in in­ter­est rates shows that more bond in­vestors be­lieve there’s some or other re­gres­sive event in the off­ing and that es­pe­cially the in­fla­tion rate could re­main low for a long time, even tend­ing to de­fla­tion.

How­ever, in­vestors in shares are now pre­pared to buy shares at in­creas­ingly higher price:earn­ings ra­tios, which show that their op­ti­mism is ris­ing.

Some­where in the fu­ture the sen­ti­ments of the two groups of in­vestors will co­in­cide again – to the great ad­van­tage of one group and the de­spair of the other.


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