Money market interest rates have remained stable since the September Monetary Policy Committee meeting. The general view of the market is that interest rates will remain stable in the medium term, however there is some expectation of further interest rate cuts as the rand continues to strengthen against the dollar.

The repo rate of 6% is 2.5% above the latest inflation number of 3.5%. The Monetary Policy Committee would probably have to believe that inflation is going to remain at or below these levels to cut rates further. However, the inflation rate's downward momentum seems to be slowing as certain basic goods are beginning to appreciate in price. In addition, while the rand has appreciated 10% against a basket of currencies over the past year and 27% over the past two years, this tailwind of an appreciating currency cannot continue indefinitely. If the rand stabilises or begins to depreciate the outlook for inflation is less promising than the current 3.5%.

The duration of the Fund as of 30 September was 75 days.

The money market yield curve rallied over the past month as investors began to discount a further interest rate cut. The renewed expectation was brought on by the steadily lower inflation rate, stable rand and subdued private sector credit extension.

A further 50 basis point cut in the repo rate will take it down to 6%. If the Monetary Policy Committee is targeting a 2.5% real interest rate this would imply an inflation rate of about 3.5% if the repo rate were to remain at that level. We do not believe the inflation rate is sustainable at below 4% as it is not compatible with wage increases in the high single digits and meagre productivity gains. In addition the rand is at a level where South African manufacturing businesses are struggling to compete with global competitors, possibly leading to a deteriorating trade balance. A weaker rand could reverse the recent decline in the inflation rate.

We believe the risk reward of the longer dated money market assets is no longer favourable and have started to reduce the duration of the Fund and invest in more floating rate assets. The duration of the Fund as of 30 June was 85 days.

The Monetary Policy Committee's decision to cut interest rates by 50 basis points took the market by surprise. The entire money market yield curve has rallied by at least the full 50 basis points and in some cases a little more as investors are now pricing in a chance of a further rate cut. Fortunately the duration of the Allan Gray Money Market Portfolio was close to the maximum before the rate cut so the full 50 basis points will be felt in the Portfolio's yield relatively slowly.

The inflation outlook is still benign but interest rates are now at a fairly low level relative to the inflation rate and the economy seems to be recovering. Considering these factors the probability of an interest rate cut is now lower. We now see less value in the longer dated money market assets and the duration of the Portfolio could decline over the next few months. The duration of the Portfolio on 31 March was 100 days.

The Monetary Policy Committee has left interest rates unchanged for the past five months, this is a fairly long period of stability by historical norms. Since the August 2009 interest rate cut, the inflation outlook has improved with consumer price inflation moving into the target range and the rand continuing to strengthen. Credit extension is also weak. As a result of the improvement in the inflation outlook we think the probability of an interest rate cut in the near term is greater than that of an interest rate hike.

For this reason we believe there is good value in the long end of the money market yield curve, and the duration of the Fund is 83 days, close to the maximum allowable 90 days.