Lower interest rates, although a life jacket for those in debt or with home loans, have negative consequences for savers. The repo rate is currently at 3.5%, the lowest in the country’s history, but with members of the South African Reserve Bank’s Monetary Policy Committee subtly altering their collective stance on rates at their March meeting, where to from here for rates and money market returns?
The March Monetary Policy Committee meeting finally saw members vote in unison to keep rates on hold. This is important, as it signifies their sentiment that we are at the bottom of the interest rate cycle. Members who previously voted for further rate cuts are now of the opinion that such action is no longer appropriate.
Why? The answer is inflation.
Fears of inflation have been driving global and domestic fixed-income markets to extreme levels all year. US 30-year government bonds have fallen by around 16%, year to date, as the market looks for US COVID-19-related stimulus spending to wreak havoc on consumer prices.
After a multi-year slump in inflation to benign levels, investors earning a fixed rate are justifiably nervous should this situation finally change.
Our Reserve Bank is closely watching foreigner capital market outflows from South Africa and is of the opinion that foreigners need to see stability of inflation to comfortably invest here. South Africa is hugely reliant on non-resident flows given that our domestic savings are not sufficient to balance our national budget and to cover our funding requirements for successive years.
So where to from here, and will the anaemic rates soon change?
It will still be a long time before money market funds enjoy the types of pre-COVID-19 rates of return of 7-8%. The South African Reserve Bank’s Quarterly Projection Model forecasts the repo rate above 6% by the end of 2023. Investors therefore must continually re-evaluate their ability to take on risk if appropriate to their situation.
At the end of March 2021, year-to-date and year-on-year respective total returns in South African money market (1% and 5%), bond (-2% and 17%) and equity (13% and 54%) investments illustrated wide disparities.
What does this mean for money market investors?
The immediate impact is that returns fail to keep up with inflation when the gap is very narrow. However, the tide will eventually turn.
Until then, over the long term, riskier assets, such as equities, have the potential to generate higher returns, so investors looking for growth should be cautious to exclude these from their portfolios in a low interest rate environment.
However, there is no one size fits all solution. For the extremely risk averse, it may make sense to stay in a money market fund or in a fund with very low volatility. However, for real long-term growth, some exposure to riskier asset classes is essential.