The Jekyll and Hyde of low interest rates
In 1886 Scottish author Robert Louis Stevenson published a novella titled The Strange Case of Dr Jekyll and Mr Hyde. The work, according to website wikipedia.org, “is commonly associated with the rare mental condition wherein within the same person there
The South African Reserve Bank’s (SARB) interest rate decision hinges on the outlook for domestic inflation (primarily) and economic growth. In its simplest form the central bank’s inflation targeting policy calls for an interest rate hike when inflation rises above the current 3% to 6% target range and a cut if it falls below. Last Thursday, 19 January 2012, the Monetary Policy Committee (MPC) elected to leave the repo rate unchanged at 5.5%. Rates have now been on hold since 17 November 2010 when they were cut by 50 basis points. “Since the previous meeting of the MPC, the outlook for domestic inflation and economic growth has deteriorated, posing a serious challenge for monetary policy going forward,” said Gill Marcus, governor of the SARB. South Africa’s economic growth forecast has been revised downward for 2012 due to continued concerns over the financial stability of the Euro-zone. At the same time consumer price inflation – measured at 6.1% year-on-year in December 2011 – has been revised upwards to peak at 6.6% this year.
Celebrating lower for longer interest rates
Interest rates have pegged at this historically low level for much longer than expected. At the beginning of 2011 economists reckoned the MPC would hike interest rates by latest December of that year. This never happened and as we enter 2012 they now expect rates to remain “lower for longer”. Malcolm Charles, portfolio manager at Investec Asset Managers said interest rates will remain at 5.5% “for a long time”. And Cees Bruggemans, chief economist at FNB agreed: “As things stand, these low interest rates may continue to prevail throughout 2012 and even into 2013, depending mainly on how global developments affect our inflation and growth.” It will take a number of years to address the debt problems in countries such as Portugal, Italy, Ireland, Greece and Spain. And global growth will only kick in once viable solutions have been found.
The Jekyll (good) side of the current low interest rate environment centres on our ability to service debt. For as long as rates remain unchanged the country’s heavily indebted consumers will enjoy respite in the form of manageable monthly debt repayments. “South Africans will continue for the time being to enjoy interest rates that are at a long term low, with prime at 9%, benefiting borrowers in all the various credit categories,” said Bruggemans. Most mortgages and hire purchase agreements are fixed to the retail bank’s prime lending rate which is in turn linked to the repo rate. Those plying their trade in the domestic housing and motor industries will be holding thumbs that rates remain on hold indefinitely. Imagine the pain in these struggling sectors were Marcus to hike rates this year.
The flipside of the coin
Low interest rates are bad news for investors who rely on interest income. “Interest rates globally are going to stay lower for a lot longer than was originally anticipated, so fixed interest investors need to adjust their expectations for lower returns,” observed Charles. The “cash is trash” phrase used so often in the past few years remains in force and the asset class is forecast to deliver a meagre 5.5% return this year. With inflation at 6%-plus those sitting in cash-heavy investments will be going backwards (in real terms) through 2012! And in the current environment the fixed income fund managers will have to know their game to generate 7.5% to 8%.
Managers such as Investec Asset Managers will focus on South African corporate debt to bolster their fixed interest returns. “Corporate debt remains one of the most attractive investments across the fixed interest spectrum and provides the necessary yield enhancement to ensure decent returns,” said Charles. Large state-backed institutions (such as Transnet and Eskom) as well as large listed entities are often in the market for credit and offer better returns than traditional cash opportunities. And they’ll be able scoop up government-backed debt with even better rates of return thanks to the ongoing Gauteng toll road saga… The South African National Roads Agency (Sanral), which has already sold more than R20 billion in bonds since 2008, will have to go to market for more cash at higher interest rates this year.
Investment Solutions economist Chris Hart warns that the current low interest rate environment is untenable. He is on record that the cocktail of high inflation / low interest is stifling economic growth. At an Investment Solutions presentation, November 2011, he said the country’s 5.5% repo rate was too low to encourage growth, with inflation (then 5.7% and now 6.1%) too high to make savings worthwhile. There is little hope for a pro-saver solution. The central bank is currently fixated on addressing slow economic growth rather than tackling inflation, confirming the “lower for longer” view expressed by various market commentators.
Editor’s thoughts: Risk and return are critical concepts in the financial advice space. The challenge is to match your client’s risk appetite to an appropriate financial product. How do you position your conservative clients when the returns on offer from interest-linked and income products are so low? Add your comment below, or send it to [email protected]
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