Will we see rate hikes up the wazoo this year?
Local mortgage holders entered 2023 in a state of resignation, having soaked up no fewer than seven interest rate hikes in the preceding 13-months, sending the repo rate up from 3.5% to 7%. To make matter worse, many economists are warning of tough times ahead and refusing to rule out further central bank action to fight out-of-control inflation. The prevailing macroeconomic environment is making it difficult for consumers and the financial advisers handling their investment portfolios to figure out what comes next… Will we seek rate hikes up the wazoo this year, or something less frightening? PS: ‘up the wazoo’ is an idiom meaning ‘in large quantities’, and not something you scream at the Eskom board when you hear about permanent Stage 2-3 loadshedding.
Some sunshiny interest rate news on the horizon?
According to a team of four economists at First National Bank (FNB), the end of the South Africa’s interest rate hiking cycle is in sight. “The year 2022 was clouded with volatility as heightened geopolitical tensions and aggressive monetary tightening sparked uncertainty in markets,” they write, in their latest Economics Weekly publication. “This year, we should experience the impact of central bank efforts through a moderation in economic activity and slower inflation”. What these economists are saying is that seven repo rate hikes since November 2021 have slowed South Africa’s economic growth and put the brakes on inflation. Sunshiny news if you were hoping for lower interest rates; but rather gloomy news if you were cheering for domestic GDP growth.
Central banks keep a close eye on economic growth because it is among the metrics that indicate the success of their monetary policy decision making. The trick is to tame inflation without destroying economic growth; but unfortunately, the Monetary Policy Committee (MPC) of the South African Reserve Bank (SARB) is battling a range of abnormal domestic constraints. “Locally, loadshedding continues to impede growth [while] the global slowdown will weigh on export earnings,” notes FNB. As we pen this newsletter, we have just seen a news24.com headline that promises “permanent loadshedding of between Stage 2 and 3 for next two years”. You have been informed, dear reader: for households and small businesses, it looks like solar or bust.
Blame Eskom, they deserve it
Eskom is also among the reasons that a group of economists surveyed by Bloomberg in the second week of January give South Africa a 45% chance of slipping into recession during 2023. And although some asset managers and economists are still pencilling in GDP growth of between 1% and 1.5% this year, we think the BNP Paribus estimate of 0.2% is nearer the mark. Despite (or perhaps because of) this gloomy growth outlook, the FNB economists seem confident we will only see one further interest rate increase this year. “We think that the SARB’s hiking cycle will reach its terminal at their upcoming meeting as inflation moderates towards the 4.5% anchor,” they write. “Monetary tightening continues in advanced economies, but hikes are likely to become shallower as inflation slows and the peak of the current cycle comes into view”.
The state-owned electricity provider is causing trouble in all the metrics that the SARB tracks. On the one hand, the lack of consistent power supply is dragging South Africa’s GDP growth rate down, on the other, the almost 19% price increase awarded to the firm is pushing consumer price inflation (CPI) higher. “Furthermore, the impact of loadshedding should keep input costs elevated and threaten supply in some instances … price setters still see inflation remaining above target over the policy transmission horizon,” writes FNB. It is difficult to say with certainty how the MPC will digest this information, though FNB holds that “ultimately, slower domestic economic growth this year should provide another factor in alleviating any further upward pressure on local rates”. And that means the MPC will likely hit consumers with another 50bp hike in January, hopefully making 7.5% the ‘top’ of the current cycle.
Why financial advisers care about interest rates?
Inflation and interest rates go hand-in-hand and have a significant impact on consumers’ disposable income and required investment returns. They also influence financial market returns and are thus valuable inputs into return expectation calculations for various asset classes. By way of example, higher inflation raises the return hurdle that your clients’ investment portfolios must generate. It also increases the cost of goods and services that your clients purchase, leaving less disposable household income with which to invest and / or purchase financial products. The central bank then hikes interest rates to try and tame inflation, which creates further pressure on the expense side of your clients’ household budget through increased car and mortgage payments.
From a financial planning perspective, the focus should be on ensuring that clients’ monthly expenditures and incomes are in balance regardless of the inflationary / interest rate environment. A product review may also be indicated, to ensure that any short-term savings are yielding appropriately for the prevailing interest rate… As for longer term investments, the job of generating real returns in your clients’ portfolios remains in the hands of the asset managers you have selected. These asset managers are responsible for selecting underlying investments that deliver on their fund mandates through the various economic cycles.
Getting exposures and timings right
Equity fund managers will, for example, ensure that their equity choices are skewed towards companies that do better in high inflation environments. Multi-asset managers will do the same with their equity exposures; but will also think carefully about the timing of increased exposures to corporate and government bonds. Remember, bond prices and yields are inversely correlated … the higher the yield, the lower the bond price and vice versa. So, the big question becomes: when will the SARB start cutting interest rates again? And is it too optimistic for consumers to expect some respite before the year-end?
Given the lacklustre economic growth outlook, this writer reckons cuts are definitely on the cards… But he would rather leave it to the FNB economists to do the forecasting: “Real rates should turn positive in the first quarter of this year, and surpass neutral by the third quarter,” they write. “And that means that the MPC will have enough space to support the economy before year-end … there is the possibility that the MPC delivers only 25bps, avoiding too restrictive a policy in a weak economic environment”.
Writer’s thoughts:
Love them or hate the, the South African Reserve Bank (SARB) seems to have done an excellent job of keeping South Africa’s monetary policy on the proverbial ‘straight and narrow’. What adjustments should financial advisers make to clients’ portfolios, assuming the repo rate ‘tops out’ at 7.5% in 2023? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected].
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