BNY’s Bob Savage argues that South African Reserve Bank (SARB) is likely to lead emerging market tightening as South Africa reverses its easing path and hikes the repo rate back to 7.0%. The report notes improving inflows and mining-related support for South African Rand (ZAR), but stresses that higher U.S. yields and Fed policy set the bar, requiring more forceful Emerging Markets (EM) moves to maintain credibility and stabilize South African government bonds (SAGBs).

SARB leads EM rate reversal

"A shift in the Fed’s policy stance has reset the benchmark for emerging market central banks. On the back of surprise hikes in Asia to defend currencies and avoid excessive outflows, there are many candidates in EM that can follow, especially if fiscal performance is also under pressure, or other idiosyncratic factors come into play. Turkey is seen as a candidate, especially with growing reserve stress, but South Africa is likely to take the lead this week as it reverses course and hikes the repo rate back to 7.0%."

"This marks a sharp reversal from the easing path the SARB had established before the conflict, which had been reinforced by a lower inflation target and an unexpected terms-of-trade boost from surging precious metals prices. There was even talk of new fiscal rules to strengthen credibility, but there will be little appetite for such steps at present. As core inflation rebounds above 3.5% y/y and headline inflation returns to the 4.0% handle, swift anchoring of inflation expectations is necessary."

"On the positive side, our data indicate that markets have not totally shifted their view on policy credibility, and inflows have generally been improving year to date. Mining/materials equity flows can still benefit the ZAR and local markets selectively, while swift consolidation of the real-rate buffer will contribute to stabilization in SAGBs. "

"The main challenge for EM countries’ financial accounts for the rest of the year is where U.S. yields and Fed rates stand. SARB and its peers will hope that no more than a handful of precautionary hikes are needed, but the bar is set by the Fed – any rate increases will require more forceful moves from EM peers."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor.)