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Comment                                                                                22 March 2017

What next, SARB?    

by Cees Bruggemans                 words 950

Despite years of economic weakness, and below potential growth, SARB has remained risk vigilant with an upside bias to interest rates. Is that stance finally to be challenged by unfolding events, or reinforced anew? Rate cuts or further hikes next?

SARB sense of risk has focused on the Fed having to raise interest rates in a normalising cycle, now reinforced by Trumpian fiscal plans, reflecting faster US growth and inflation, leading to a stronger Dollar and (possibly aggressively) higher US bond yields, and this in turn having many negative consequences for the outside world, especially downward pressure on global commodity prices and Emerging Markets currencies.

 

Such instability, and domestic political instability, including a demanding labour market, would see higher SA inflation pressure. While still presently at very low interest rates (repo of 7%, prime of 10.5%), SARB has been inclined to maintain an upside bias to interest rates due to these risks.

Is that still quite warranted?

The basic concepts underlying the SARB world view these past few years have not necessarily proven wrong. But they have proven dormant under strangest of circumstances.

US economic revival, as reflected in a labour market with 4.8% unemployment, and a slightly faster inflation rate, overall as well as core, seemed to warrant higher US interest rates. None more so than when overlayed by Trumpian fiscal plans, less destabilization risk from the outside world (China?) and a stronger (though somewhat volatile) Dollar.

And yet the implosion of commodity prices and Emerging Market currencies has stayed in abeyance, at least until now. Why?

The Fed these past five months has refused to price a Trump fiscal premium into its thinking, on the basis that it doesn't know what to assume. That initially seemed rash, indirectly questioning Trump intentions. The US equity market and Dollar certainly weren't that shy, going robustly higher, and US bond yields nearly immediately repriced higher, until comparatively recently.

But the US 10yr bond yield hasn't really cracked the 2.6% ceiling, drifting lower once more. And with spreads with Europe narrowing once again, the Dollar has eased anew. The markets, it seems, have at least partially come into line with Fed thinking and caution.

Part reason seems to be the difficulty of getting complex decisions through the Congress and Supreme Court. In both areas, Trump has met resistance, not necessarily totally defeating, but still in places (a fragmented Republican Congress) real enough to lengthen timelines and dilute some of the wildest intentions, and their fiscal price tags.

If anything, uncertainty has increased, with a bias in favour of gradualism. The Fed is certainly no runaway train, remaining dovish in its readings and projections, while the Trump fiscal agenda appears to have become less of a runaway train, still on track but going slower than expected.

From this mix of forces comes yet another surprise, namely that global forces (Chinese demand and producer supplies) have kept commodity prices up (especially iron ore over $90 which late last year already had been expected to fade closer to $50-60). But the real cherry, not unrelated, has been Emerging Market currencies, generally not railroaded by American events, but instead supported by their own attractive yields and a US and global financial system remaining risk on.

This combination of external events has helped to erode our current account deficit on the balance of payments (helped by weak domestic import demand) and has assisted the Rand steadily firmer, today nearer 12.60:$ compared to reaching 18:$ some 15 months ago.

This Rand firmness has been achieved despite much domestic political uncertainty, with many outrageous political and public sector scandals sapping business confidence, the RMB/BER business confidence for instance still on only 40. With a country on notice of an imminent credit down rating to junk due to growth stagnation, institutional thrashing, and far too much political uncertainty, one would have expected such unpalatable risks to have resulted in a weaker Rand. Even if our own labour climate has proved less challenging this past year.

Yet the mix of global forces apparently outweighs all. And these seem to dictate that our currency stays in lockstep with our peers (some of whom may have worse domestic problems than our own).

Where does this leave the SARB?

Our inflation rate has in any case peaked on account of devastating drought price effects being left behind, and the oil price also being off recent peaks, possibly due to uncertainty within OPEC and with non-OPEC producers.

The jewel in the crown, however, is the Rand at 12.60:$ and still apparently not quite finished firming. This further underwrites a fading inflation rate well back in the 3%-6% target zone ere long, and this despite stiff April sin tax and fuel levy increases.

SA inflation risk fading, SA growth still deeply disappointing, relevant global risks (American, Chinese) apparently less intense than expected. A plausible formula for SA rate cuts (plural) this year rather than hanging around present levels, or even going higher?

SARB diehards may still differ. The global transition these past few months may have stayed benign, but it may not stay so indefinitely. All the old evils are still lurking in the background?

One can never be certain of anything, granted. A setback, and Rand weakening, could still materialise at any time. Domestically, our worst political fears may still suddenly be realised. And then what?

Even so, the outline of our reality seems to have firmed of late. It is more benign than believed for a long time. Even SARB may get persuaded, eventually. If it is, rate cuts could follow.

Now that would be a welcome mild antidote to the impoverishing fiscal moves. And so we wait on events to show the SARB’s hand.

 

Cees Bruggemans

Bruggemans & Associates, Consulting Economists

 

Website www.bruggemans.co.za

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