Rate cuts look less likely as inflation remains sticky

Financial and risk advisers who were hoping for better economic growth or interest rate cuts to lift the mood at upcoming client interactions will be sorely disappointed. As the 29 May 2024 National Elections loom, all you can truthfully report to clients is another downward revision in South Africa’s GDP growth forecast. And as for interest rates, you could hint at a possible pre-election windfall; but deep down you know the South African Reserve Bank (SARB) has been tough on inflation, and is unlikely to cut yet.

Recession fears, rate cut hopes ‘up in smoke’

Nadeem Hoosen, DFM Portfolio Manager at INN8 Invest offered up a mixed bag of economic and fund management news during a recent ‘first quarter update plus balance of 2024 outlook’ presentation. The good news is that the recessionary fears that took hold in developed market over the past two years have finally dissipated. “The fears of recession that dominated markets over the last two years, especially in the United States (US), have dissipated [largely thanks to] buoyant growth out of the US,” Hoosen said. The bad news is that there will be fewer rate cuts out of the US than expected, beginning much later in the year. 

According to Hoosen, the US market is now pricing in only two or three rate cuts totalling one to one-and-a-half percent for 20204 compared to the six that many analysts were pencilling in as the year got underway. The bottom line is the US Federal Reserve (Fed) will not act on interest rates until inflation is under control, something that is proving difficult given the resilience of the US labour market. “US inflation has surprised on the upside in the latest print, at about 3.5%,” Hoosen said. This is tough news for local investors because the consensus view is that the SARB will follow the US on rate cutting decisions, and only if its own inflation data warrants same. 

Strong equity performances out of the US and Canada lifted the MSCI All Country World Index higher over January to March 2024, led by companies in the semiconductor and semiconductor equipment sectors. “Equity returns were driven by company fundamentals rather than macro events as fourth quarter 2023 earnings exceeded consensus expectations, driven by key themes like artificial intelligence (AI) adoption and infrastructure growth,” Hoosen said. Sadly, South African equities kicked off 2024 with a disappointing 2.3% contraction over Q1. 

The usual suspects weighing SA Inc down

The portfolio manager listed the now familiar domestic economy and financial market constraints. These include downward revisions to domestic listed company earnings; the impact of higher-for-longer interest rates on local consumers; concerns over weakness in emerging markets; and the well-documented electricity and logistics woes courtesy Eskom and Transnet. INN8 pointed out that the JSE’s resources (+15.6%) and technology (+6.9%) sectors had rallied in March; but this was largely due to strong improvements in the gold price. The specialised commodity companies focussing on coal, iron ore, oil and platinum struggled. “Other JSE sectors that were negatively affected by interest rates were financials, with the big four banks down 7% on average,” Hoosen said. 

Bonds had a tough quarter too. Hoosen noted that global bonds came under pressure in Q1 as the US Treasury yield rose from 3.86% to 4.25%, and the Barclays Global Multiverse Bond Index fell 1.9% in dollar terms. “Local bonds followed the weaker global trend, with the 10-year yield on the government bond arising from 11.2% to 12% and the All Bond Index falling 1.8% for the quarter,” he said, before sharing a couple of unpleasant truths about South Africa’s economic growth and inflation. First, the latest headline inflation number topped 5.6% and second, the International Monetary Fund (IMF) revised the country’s 2024 GDP growth to 1%, from 1.6%. 

Upbeat on US bonds, equities

The first quarter news is ‘locked in’ and there is little point in dwelling on it. You and your clients should be more concerned over the outlook for various asset classes over what remains of 2024. Hoosen started the outlook portion of his commentary on an upbeat note, pointing out that US equity and bond markets usually performed well when emerging from an interest rate hiking cycle. “The market is expecting continued growth in global equity and bond markets once the Fed starts to cut interest rates,” he said. But it is more difficult to get enthusiastic about local prospects. 

The case for South Africa Inc is rather subdued given the mere 0.6% GDP growth achieved in 2023; and National Treasury’s 1.6% and 1.8% forecasts for the following two years are nothing to rave about either. Investors also remain nervous about the outcome of the looming National Elections with the result they are taking somewhat of a wait-and-see approach on financial decision making. There is a glimmer of hope in that 60% of the revenues flowing into JSE-listed are generated offshore. “A large percentage of company earnings is coming from offshore rand-hedge type earnings, and that could bode well for our local market and companies,” Hoosen said. 

In an attempt to add some positive ‘spin’ to this newsletter, the writer studied a recent PwC South African Economic Outlook paper, titled “Unlocking Foreign Direct Investment (FDI) as a driver of business and economic development”. Some of the statistics shared in that paper suggest that foreign investors are seeing value in the local economy, albeit in private market rather than listed equity type opportunities. Case in point, South Africa “attracted a net inflow of FDI every year since the global financial crisis” including inflows amounting to R96.5 billion in 2023. 

R5 billion gets 9 000 jobs or so…

PwC crunched some numbers for a notional R5 billion brownfield capex investment in the automotive manufacturing sector to reveal that such investment would “yield R3.5 billion in additional GDP; create and / or sustain 9 000 jobs in the upgrade process; and contribute R673 million to the fiscus. The only caveat is that around two thirds of this capex must be spent on local goods and services. But the upbeat tone in this paper was somewhat undone by the recent offer by BHP Billiton for Anglo American excluding any of its South African assets. Within hours, the Presidency moved to dismiss media speculation that this was a sign of reluctance to invest in the country. Smoke, fire, QED. 

Returning to the market outlook, the portfolio manager commented that local bond valuations remained attractive relative to cash and emerging market peers. Furthermore, investors should get a reasonable return from this asset class for the remainder of 2024, even if interest rate cuts disappoint. Offshore diversification is crucial as the number of shares on offer on the JSE dwindle. But INN8 noted that US companies would have to deliver reasonable earnings to maintain current valuation, especially in the AI and technology sectors. Their preference is for emerging markets with some Chinese counters showing promise. 

Elections plus Middle East conflict ‘red flags’

As for the ever-present red flags. “There are some Middle Eastern tensions at the moment which will impact the oil price; and then the key election outcomes locally and abroad [introduce significant uncertainty],” Hoosen said. Portfolio managers across the group are monitoring developments in these areas and will adjust exposures accordingly. To conclude, he said the base case for the remainder of the year was for bonds and equities to outperform cash through the rate cutting cycle. 

Writer’s thoughts:

The higher-for-longer domestic interest rate environment is causing significant hardship for South African households and mortgage and other debt servicing costs eat into disposable income. Do you believe your clients will survive deep into 2024 at the current 8.25% Repo rate? Please comment below, interact with us on X at @fanews_online or email us your thoughts editor@fanews.co.za.