Interest Rate Cycles

By Nedgroup Investments

The Monetary Policy Committee is holding their scheduled May meeting over the next two days and is expected to announce further interest rate cuts on the afternoon of Thursday 21 May.

The Forward Rate Agreements (FRAs) indicate that the market is pricing in at least a 50bps cut on Thursday and a 90% chance of a further 50bps cut in July this year.

Taquanta Asset Managers, who manage all of the Nedgroup Investments Cash Solutions funds, believe that under the current circumstances there is scope for SARB to cut rates by a further 100bps on Thursday.  But we will have to wait and see how SARB decides to react.  Inflation is not a threat and as we all well know, the country is firmly in recession with a long and difficult road back to economic growth ahead of us. 

The money market fund proposition of yields that comfortably exceed the call rate, with full liquidity and diversification, has been proven to work through all interest rate cycles. This is because the funds hold a blend of both longer dated instruments and call funds. The call deposits provide the fund with liquidity. The longer dated instruments provide the fund’s yield premium over call rates, as issuers reward the fund for placing deposits for longer terms – even if these are of a floating rate nature.

As is evident from the chart below, no two cycles are the same. The 2003 to 2009 cycle was shorter and significantly deeper than the 2009 to 2014 cycle. As interest rates test levels last reached in the 1970’s, based on the current economic circumstances, it appears likely that following the sharp decline in rates, the upcoming cycle will be long with a very gradual increase.  
 
South African Repo Rate (%)
 
Source: Global-Rates.com
 
 
In line with Taquanta’s approach to managing liquidity, all of The Nedgroup Investments Cash Solutions funds are comprised predominantly of floating rate notes. Hence, unlike call rates and fixed deposit rates for new deposits, which will drop immediately with a reduction in the Repo rate, the decline in fund’s yields will lag. We will publish the illustrative phased impact of any rate cut on our funds, following Thursday’s announcement.

The market is normally quite efficient at pricing in interest rate moves, and rates offered by banks in the lead up to anticipated rate moves therefore price these in ahead of time. But surprise rate cuts, or cuts larger than those expected by the market, favour the money market funds which under such circumstances are able to offer higher yields than call - for longer.