Kyle Coertze, Investment Analyst at Cartesian Capital
South Africa begins 2025 with the widest gap between the Repo rate and headline inflation in more than 20 years, currently at 4.35% – more than four times the historic average spread of 1.17%.
Repo Rate vs Inflation Rate
Money market funds invest in instruments such as treasury bills, bank paper, commercial paper, and negotiable certificates of deposit, and are structured to prioritise capital preservation while offering steady returns.
Historically, money market funds have been a place to “park capital” while deciding which riskier asset class to be invested in, but in a market where long-duration assets face heightened price volatility, the short-term nature of money market instruments combined with real returns of 5.5% provide two distinct advantages, ensuring greater stability and more predictable outcomes for investors;
and in this economic environment, should be receiving higher asset allocations in all portfolios.
In uncertain times, the ability to quickly access funds or re-allocate capital is invaluable and the liquidity Money Market funds offer is an immeasurable advantage and are an essential component of any well-diversified portfolio.
For institutional and retail investors alike, the combination of liquidity and competitive yields makes money market funds a prudent choice heading into 2025.
Economic and Market Outlook 2025
The start of 2025 signals a subtle yet meaningful shift in the global economic narrative. Market participants, who once expected aggressive rate cuts from central banks, are now adjusting their outlooks. In addition to these revised expectations for fewer rate cuts, yield curves across multiple markets, including our local SA market, have been steadily moving higher following previously enacted rate cuts – an outcome that diverges from conventional economic theory. This shift highlights the potential for short-term fixed income investment vehicles, such as Money Market Unit Trusts, which typically yield a spread over JIBAR (closely tied to the Repo rate), to offer attractive relative returns, particularly in a low inflation environment.
In the US, UK, Eurozone, and South Africa, 10-year benchmark government bond yields are now higher than when their respective central banks began reducing rates. Notably, the US 2-year treasury yield recently surpassed the Effective Federal Funds Rate, signalling that markets view current rates as at or near their peak. This development has led to speculation about the possibility of a rate hike in the US late in 2025.
US Effective Federal Funds Rate vs 2yr Treasury Yield
Concerns over unsustainable fiscal deficits, resurging inflation, and trade policy disruptions have all played a role in the recent global bond sell-off. These rising yields, driven by “the wrong reasons,” have eroded investor confidence in the fixed-income market, leaving bondholders vulnerable to increased volatility and capital losses. South Africa’s yield curve moved lower only on the short end (<1 year) after the SARB initiated rate cuts on the 18th of September 2024. Investors that had been holding bonds in the capital market (more than one year out on the curve), would have seen capital losses by now (remembering that yields and bond prices move in opposing directions).
South Africa Sovereign Yield Curve
Equities performed reasonably well since the establishment of the Government of National Unity, but it has been primarily local investors driving the buying activity. Foreign investors were net sellers of South African equities in 2024. For net foreign flows to re-enter our equity market in 2025, international investors will need to see tangible, structural growth in the economy rather than mere optimism.
The uncertain outlook for our equity market, coupled with the recent unsettling movement in bond yields and growing uncertainty heading into 2025, has driven increased interest in Money Market Funds. These vehicles offer appealing yields without the duration risk (sensitivity to interest rate changes) typical of bond funds, or the volatility inherent in equity funds.
While our base case anticipates a 25bps rate cut from the SARB in both January and March, the Central Bank may be more cautious than expected, influenced by a combination of domestic and external factors.
The FRA curve now reflects just one 25bps rate cut priced in for 2025. A key risk to sustained rate cuts is the potential recalibration of the inflation target to a lower band, as proposed by Governor Lesetja Kganyago, pending approval from the Minister of Finance. Although inflation expectations have fallen, signaling improved price stability, the external environment remains complex. The Federal Reserve’s hawkish stance, with only two additional 25bps rate cuts projected for 2025, has bolstered the US dollar, which could exert upward pressure on imported inflation in South Africa. These dynamics may prompt the SARB to adopt a more gradual approach to rate cuts.
ENDS
