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Following the path of global and local interest rates has proved an emotionally fraught exercise over recent years. But just as investors around the world were breathing a collective sigh of relief at the increasingly likely prospect of a definitive end to the recent interest rate hiking cycle and the start of a cutting cycle, this likelihood has faded. And it’s not just markets that have been whiplashed; the US Federal Reserve (Fed) too has had to swing to and fro according to the latest data. Having made a dovish pivot late last year, as inflation data showed strong downward momentum, the Fed has had to walk back market interest rate cut expectations as US growth has proved durable and inflation sticky at levels well above target. 

 

Risk of a Fed rate hike

In mid-April, Fed chair Jerome Powell said it is likely to take “longer than expected” for inflation to return to the central bank’s two percent target and justify cuts to interest rates. “We’ve said at the [Federal Open Market Committee] that we’ll need greater confidence that inflation is moving sustainably towards 2% before it would be appropriate to ease policy,” he said at the time. “The recent [inflation] data have clearly not given us greater confidence, and instead indicate that it’s likely to take longer than expected to achieve that confidence.”

These comments have sparked anxiety in the markets, with investors now debating the timing of the anticipated rate cuts. More concerning are the more recent murmurings that, rather than keeping US interest rates at their current levels for the remainder of the year, the Fed could even hike rates again this year, a prospect that markets were not entertaining until the last few weeks.

The reality is that higher-than-expected inflation in the US has pushed back the start of interest rate cuts in the US to at least July, if not later. Should inflation remain elevated, and growth remain strong, then there is a risk that the Fed will delay its rate cuts even further or even consider a further tightening of monetary policy. 

Our base case, however, is that US growth will gradually slow and this, combined with lower housing-related components in the US CPI basket, should see inflation ease down further over the balance of the year. This view was given some support by the recent US labour market report which showed that the net number of jobs added in April slowed sharply compared to previous months and was well below analyst expectations. At the same time, wage growth slowed and this is likely to provide some comfort to both the Fed and markets which had become concerned about just how sticky inflation might prove to be. 

Looking through the local interest rate lens

The higher-for-longer outlook for the Fed has filtered through to South African interest rate expectations. At the start of the year, money markets priced in as many as four interest rate cuts in 2024. Currently, however, markets expect rates to remain on hold through the remainder of the year. 

That’s not to say that the local economy couldn’t use some support. With interest rates at their highest levels since 2009, consumers are feeling the heat. However, we expect the South African Reserve Bank (SARB) to remain cautious. While inflation has moderated from the post-pandemic peaks, at 5.3% it is still above the 4.5% mid-point of the central bank’s 3 to 6% target range for inflation. Inflation expectations also remain relatively elevated, and the Monetary Policy Committee (MPC) has consistently emphasised that it would like to see these anchored around the mid-point of its inflation target. 

Politics are also likely to play a role in rate setters’ thinking. For the first time since the dawn of democracy in South Africa, the ANC looks set to fall below 50%, meaning South Africa is entering an era of coalition government at a national level. This poses a considerable risk to the policy outlook. The SARB will want to see what the post-election policy outlook is and how financial markets react to that before it makes any decisions on interest rates. This rules out a move at the next MPC meeting, which takes place a day after the election, and means that any thought of rate cuts will need to wait until either July or September. Even then, this will be subject to underlying trends in inflation, the path of US interest rates and the post-election political landscape. 

Therefore, with elections later this month and the Fed likely standing still until later in the year it’s likely that rate cuts here will come later rather than sooner this year. DM/BM

By John Orford, Portfolio Manager, Old Mutual Investment Group

 

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