The Monetary Policy Committee (MPC) left the repo rate unchanged at 7% during August, stating that it is "inappropriate at this stage" to change the monetary policy stance in view of the current risks to the inflation outlook, the most obvious risk being the oil price. However, the MPC also indicated that members were watching the current round of wage negotiations for signs that the downward trend in wages would continue, and noted that strong levels of expenditure in South Africa continued.

The money market yield has moved higher during the quarter, no longer showing expectations for short rates to fall but rather pricing in the first of the repo rate hikes. The two-year NCD at 7.7% suggests that interest rates will be 1% higher by September 2007. Just a few weeks ago money market yield curves were factoring in interest rate reductions, given the strength in the currency. With the surging oil price, partly due to damage done to US oil supplies and refineries caused by Hurricane Katrina, sentiment did an about-turn. Cash outperformed bonds again this quarter, as they did in the first quarter of this year, returning 1.71% versus the All Bond Index which returned 1.10%. This was expected, as the risk of holding bonds is increasing as inflation becomes more of a concern.

Domestic macroeconomic data for August (released in September) showed that inflation is rising. Inflation at the consumer (CPIX 4.8%) and producer (PPI 4.2%) levels were largely in line with expectations but higher than we have seen in recent months. Most analysts for the first time are conceding that there is no longer a chance of further interest rate easing given these numbers and that indeed the first repo rate hikes are visible on the horizon.

The Coronation Money Market Fund has returned 7.24% for the last 12 months, outperforming its benchmark by 7 basis points for the year. It has shot up in the relative rankings as calculated by Micropal with the September 2005 figures showing a position of number 1 out of 20 for the year to date. The fund has taken on substantial new investments during the quarter, with the fund now R1.3 billion in size.

Tania Miglietta
Portfolio Manager

The quarter will be remembered by yet another 0.5% cut in short-term interest rates (the repo rate) by the Monetary Policy Committee (MPC) at the South African Reserve Bank (SARB). The repo rate was cut to 7% from 7.5% following a fall in the inflation rate as measured by CPIX to historical lows of 3.1% in February 2005. With bank NCD rates at between 6.85% - 7.10%, SA shortterm interest rates are at all time lows. The MPC left the repo rate unchanged when it met in June.
The repo rate cut was unexpected by all economic analysts polled by Reuters and Bloomberg, as by then economic indicators showed that inflation had most likely bottomed and would begin to rise. This sentiment was echoed by the SARB in its Monetary Policy Statement where it showed a revised inflation forecast of 5.25% for early 2006.
The SA FRA (Forward Rate Agreement) curve, which gives us an idea of what the market in general expects of short-term interest rates continues to price in a 50% chance of a further 0.5% repo rate cut over the next few months despite a weaker currency this year
Second-quarter bond returns, as measured by the All Bond Index, were 5.29% this time outperforming cash which showed a 1.73% return. This was in contrast to the first quarter where cash outperformed bonds, returning 1.77% versus 0.81% respectively. Given the risk differentials, one would expect bonds to outperform cash over the longer term.
The performance of bonds for the quarter not only shows the impact of the April interest cut, but also the turnaround in market sentiment. The markets have changed significantly during the course of the quarter after the interest rate cut: becoming more bullish. This sentiment was sustained by the fall in US Treasuries, accompanied by relatively high levels of the global risk appetite, strong foreign purchases of SA bonds and the SARB's view that medium-term inflation faced few threats.
However, the market recently has been finding it difficult to show clear direction. The currently weaker currency, somewhat more volatile US Treasuries and stronger economic statistics seem to suggest that we have seen the last of the interest rate cuts. We are of the opinion that lowering the repo rate further under these circumstances would be adding fuel to the already roaring fire. The Coronation Money Market Fund returned 1.81% for the quarter and 7.86% for the last 12 months, outperforming its benchmark by 42 basis points for the year.
Our investment strategy for the Coronation Money Market fund remains unchanged - we are conservatively positioned, with a short to neutral duration for this year. The fund seeks to maximise interest yield for investors whilst ensuring that capital is protected.

The money market started the year on astounding bullish sentiment! There was pressure in the market for shortterm interest rates to move lower, given a persistently strong rand, the strength in the bond market and money market derivatives pricing in the next repo rate cut. This was a concern, as we believe that another interest rate cut would further fuel an already aggressive consumer spending pattern and only exacerbate inflation going forward.
By February we were pleased to note that the South African Reserve Bank (SARB) had agreed that no further reduction in interest rates was necessary and the repo rate remained at 7.50%. Money market rates have since started to edge higher as the market starts to recognise that the cycle may be turning and the very low interest rates of the past 18 months are likely to increase. The market is now pricing in a good chance of the first 50 basis points repo rate hike taking place in April 2006.
Jibar rates (Johannesburg Interbank Average) have been rising during March, indicating to us that South African banks no longer expect further rate reductions. The sharp downward move in interest rates over the last six years is visible in the chart below. The interest rate cycle may well start to turn during the course of this year.
The Coronation Money Market Fund has had a good start to the year, with its longer term performance putting us at number 2 in the one-year, six-month and three-month rankings. It has returned the following (net of fee) figures as at end of March 2005:
Given that the main objective of the Coronation Money Market Fund is to outperform prevailing interest rates without adding additional risk, the fund has successfully delivered this on a consistent basis.
Going forward we expect an ongoing sell-off in the bond market (we have just seen the beginning), and a gradual upward movement in money market rates will follow. The imbalances in the current account will lead to a weaker rand over time and ultimately push inflation higher. Economic indicators show that the demand side of the economy is strong which should lead to higher prices. For inflation to be kept in check, the repo rate will have to rise.
We expect that by the end of the year, we will have seen the first interest rate hike of 50 basis points, taking the repo rate to 8%. The risk to this view of course is that a rebound to the rand/US dollar exchange rate back to below R/US$6.00 will impact positively on inflation, putting a "cap" on short-term interest rates.

The money market theme during the final quarter of 2004 was an unusual 50/50 split in the expectations on the direction of short-term interest rates, either lower or unchanged. In the past the short rate MPC decisions were reasonably clear and predictable. This time around, the ongoing debate on whether the repo rate would be cut or not, at both the October and December 2004 MPC meetings, was the overriding theme. After the surprise August repo rate cut and a persistently strong rand/dollar exchange rate, strong arguments supporting both existed and indeed hotly debated leading to much uncertainty across the market.
It emerged that rates were to remain unchanged, leading to an adjustment of the short-term yield curve which had been pricing in a growing chance of even lower interest rates. Short-term rates (especially short-term derivatives) during 2004 were highly influenced by the volatile and ever strengthening rand/dollar exchange rate.
The repo rate ended the year at 7.50%, with cash (3- month STeFI Index) returning 7.75% for 2004. Stable, low interest rates contributed to what may be a new paradigm for cash returns in South Africa, where in previous years double digit cash returns were the norm. Bonds returned 15.25% for the year, comfortably outstripping cash despite lagging in the early parts of 2004.
The Coronation Money Market Fund provided competitive gross returns of 8.29% during the year to December 2004 (nearly 50 basis points above the STeFI benchmark) - a pleasing, and ever increasing outperformance of the index given that the fund remains the ultimate low risk fund.
Our view going forward is for the imbalances in the current account to lead to a weaker rand over time, which will result in higher inflation. With economic indicators showing that the demand side of the economy is strong with no signs of abating, prices are likely to rise which will ultimately mean the need for a higher repo rate to keep inflation within the target bands of 3% to 6%.
This scenario is likely to unfold in the latter part of 2005/early 2006. The risk to this view of course is that a continuously strong rand will impact positively on inflation, keeping short rates down for longer.