Cash and money markets – ‘a decent hedge against inflation’
Portfolio manager at Momentum Investments unpacks how recent inflationary economic events have put cash back on the throne
Zisanda Gila, Portfolio manager at Momentum Investments
Global inflation is rising, central banks around the world are tightening policy rates, the US Federal Reserve is hiking rates in aggressive increments, and we are still faced with two expected rate hikes of 75 basis points before the year is up.
According to Zisanda Gila, Portfolio manager at Momentum Investments, the story is no different in South Africa’s local markets. “Growth remains under pressure and has been revised down by the South African Reserve Bank. The rand has also depreciated strongly since the start of policy normalisation in the major economies in addition to the slowdown in the Chinese economy.”
She says the situation is now ‘stickier’ than initially anticipated with the South African Reserve Bank (SARB) being concerned with inflation. For her, cash or money markets become a useful asset class to be invested in during stressful economic times and can be a fairly decent hedge against inflation over a short investment horizon.
Rising from the ashes and all-time low levels experienced during the covid pandemic, cash is once again becoming king. Most investors are de-risking their portfolios and switching to this asset class for steady returns as the value has returned, with the money market rates closely tracking the steepness of a forward rate curve which is frontloading aggressive future rate hikes by the SARB.
She thinks that it is worth noting the SARB’s actions to re-engineer and close the gap between the various key market rates. The SARB has implemented a Monetary Policy Implementation Framework (MPIF) over a 12-week transition period from June. This would allow an excess supply of bank reserves, which it will then use to manage this additional liquidity by accepting the qualifying reserves and paying interest on at the repo rate.
Interest rate decisions made by its Monetary Policy Committee will effectively feed through the South African economy to the rates at which commercial banks lend to its customers and businesses.
Gila says the changes proposed in the MPIF will have a significant impact for fixed-income investors since it is likely to result in changes to the supply and demand for banks offerings, especially in the short term. Amid all these changes, the cash market continues offers decent returns.
“The cash market is already trading with a surplus which is why commercial banks will be less willing to pay up for short-term primary funding deposited with the SARB at repo rate.” This will lead to a compression of short-term yields because banks will not pay investors more than they can earn by keeping their cash reserves at the Reserve Bank. She says that this will not change the banks’ requirements for long-term funding”.
“With the overwhelming view from most central banks that rising inflation needs to be met with a strong interest rate hike, globally interest rate hikes continue to rise”.
The ECB’s Governing Council had considered it appropriate to take a larger first step on its policy rate normalisation path than previously signalled. This decision is based on the updated assessment of inflation risks and aims to bring inflation back to its 2% target over the medium term.
“We thought the South African Reserve Bank was likely to follow suit after the US Fed hike and it did. In July, the repo rate was hiked by 75 basis points (bps). The Governor originally said there was a possibility of lifting the repo rate by 50 basis points (which the market saw as the highest increment at the time), and the fact that they acted sooner, gave them space to move at a more measured pace,” says Gila.
Gila expects the SARB to maintain hawkish tone in responding to local inflation and its upside risks. She sees another 100 basis point hikes before year end. But this will all depend on whether the peak in inflation is higher than viewed by the market and currency loses ground against the US dollar.
For Gila and her team at Momentum Investments, cash has been yielding steady returns and has outperformed equities and nominal bonds in recent months. “Given the current inflation environment, it is no surprise that inflation-linked bonds also had a good run.”
In terms of uncertainty and volatility, Gila says investors always regard cash as a safer asset class and it has outperformed the other asset classes in the short term. However, she warns that when higher inflation lingers for longer periods, it tends to erode expected cash returns in the long term.
“In this interest rate environment, money market funds will continue to offer attractive low-risk returns. It looks like cash is king and not trash anymore and the king has returned,” Gila concludes.