Inflation bug dead
Long-term interest rates lower than short-term ones
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.
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.