Your advice clients face ‘stage eight’ income shedding
Concerted efforts by central banks, assisted by base effects and a range of external factors, have brought global inflation within a whisper of its long-term average and created a backdrop for interest rate cuts around mid-year 2024. “Globally, inflation now sits at 3.6% though there is still some work to do to get it down to the 2% long-term average,” said Kevin Lings, Chief Economist at Stanlib.
Two economic giants, one minnow
Presenting to the Gauteng leg of the Glacier by Sanlam Investment Summit 2024, Lings set about telling an audience of financial advisers everything they needed to know about the macroeconomic factors influencing market prospects in China, the United States (US) and South Africa. Tongue-in-cheek you might say he unpacked the world’s two largest economies alongside a BRICS minnow. PS, as with most early-2024 economic discussions the talk had significant ‘death by inflation and interest rates’ credentials.
The economist said that global central banks’ two-year-long salvo of interest rates hikes was finally bearing fruit, opening the door for significant interest rate cuts over the coming 18 to 24 months. “Interest rates take time to have an economic growth effect, both to the upside and to the downside; from the second half of this year, you can expect interest rates to be cut,” Lings said. He reckoned that Eurozone countries and the United Kingdom would be first to act, followed by the US, and then others. Overall, the turnaround from a rate hiking to rate cutting cycle will support an upswing in economic activity that will benefit all countries, including South Africa.
There has been a lot of discussion among economic analysts and market commentators over when the US Federal Reserve (the Fed) will start cutting rates. Lings pointed out that the Fed was ready to cut rates but needed a few more indicators to fall into place before doing so. And there are at least three inflationary factors that might force the US central bank decision makers to sit on their hands past the expected May 2024 inflection point. First and foremost, food inflation, which remains benign despite growing concerns over climate change related disruptions to agriculture.
The food, shelter and wage trifecta
“The second thing US economists have been worried about is rental or ‘shelter’ inflation which is the biggest part of their inflation calculation [and] remained at over 6% entering 2024,” Lings said. He added that data from US real estate website Zillow pointed to a significant cooling in the sector and that this trend shift would filter through into the main measure with a 10-month lag.
The food and shelter indices may have normalised; but the third factor, being rising wages on the strength of the US labour market, could unravel the best-laid plans. To illustrate, just one day after the presentation, the US statisticians confirmed that 353 000 jobs had been added in January 2024, despite high interest rates. Other statistics that support significant pressure on wage inflation include that US companies are unable to ‘fill’ around nine million positions and that overall unemployment is pegged below 4%. Lings had the audience in stitches by suggesting that he knew where the world’s largest economy might find nine million workers.
Globally, economists remain worried that the Hamas-Israel conflict will spin out of control, drawing the US and some of its allies into a region-wide war. As things stand, conflict-related escalations have caused severe disruptions to the global shipping industry with a mere 40 ships per day navigating the Suez Canal compared to 70 pre-pandemic. On the flipside, the marine cargo traffic passing Cape Town harbour has spiked from an average 45-50 ships to over 75. “The rerouting of marine freight adds costs, creates disruption and has the potential to re-energise global inflation,” Lings said, though there were no signs of a significant impact, yet.
On a country-specific note, the presentation shared that China, once a ‘sure in’ for 5%-or-higher annual GDP growth was struggling. Reasons behind a poor growth outlook include a total debt-to-GDP ratio of around 3.5 times; declining birth rate; falling foreign direct investment; and the ongoing souring of China-US trade relations. Lings said China’s multi-year growth bonanza had been on the back of government spending on infrastructure; but that the growth had come at a cost. The most telling observation was that Mexico had replaced China as the United States’ go to market for buying ‘stuff’. People are simply not as excited about China’s prospects as before.
Have these 14 countries jumped the gun?
Lings’ whistlestop commentary on US economic prospects centred on when the US Fed would announce its first interest rate cut, and whether other central banks would announce their decisions before or after that. To address the second part of the question first, Lings said: “No, you do not have to wait for the US; but you take on more risk if you jump the gun”. Keeping in mind that the Fed was expected to begin cutting in May this year, the economist said around 14 central banks had already cut in December 2023 including Brazil, Chile, Peru and Hungary. The consensus is that South Africa will wait for the Fed to move before following suit.
Commenting on the extent and speed of US interest rate cuts, Lings said there was a long way to go from the current 5.5% to the long-term, neutral level of 2.5%. That hints at a decent reduction in interest rates over the 18-months following the first cut. The economist also sought to settle the long-standing ‘US recession or not’ debate, saying that the leading economic indicator that has been predicting a US recession for months could be wrong for the first time ever. “We do not think the US is going to go into recession because they keep adding jobs,” he said. “You cannot have a recession unless you have a reduction in the number of people employed.
The South Africa focused component of the presentation was brutal. To begin, the economist bemoaned the flatline and / or gradual decline in manufacturing and mining production over the past 20-years. Against this rather lacklustre backdrop, the country has had to lean on the consumer and financial services sectors to drive growth. “Essentially, South Africa does two things, and they are related,” said Lings. “We shop, and we finance that shopping through the banks”. Unfortunately, you cannot drive employment out of these two factors. In Lings’ words: “to go shopping all the time, and use debt to fund it, is not a recipe for economic growth”.
The constraints on the South African economy are well-documented and have been shared ad infinitum by this and other news channels. In short, economic growth will not ‘fire’ without significant improvements in electricity production and transport and logistics. And according to Lings the massive infrastructure-related constraints, also referred to as binding constraints, will prevent the economy from ever growing at more than 2% per annum. Alas, his comment re the ‘state of play’ in the South African consumer segment will keep financial and risk advisers awake at night.
The consumer has run out of money
“The consumer has run out of money; the bedrock of the SA economy, the consumer, is under pressure due to high interest rates and the fact that wages have not kept pace with inflation,” he said. The audience, all of whom advice consumers on a range of insurance and investment products, nodded in agreement.
The month-on-month decline in the country’s total retail sales is proof that real household income is falling. Consumers are increasing their personal debt levels to survive; but government’s hands are tied. “Government does not have any money,” Lings said. “They are already spending R1 billion per day, including weekends, to pay interest on their existing debt”. To end on a high, Lings shared a recipe for economic success that he has been peddling for the last decade or longer.
“You have got to use the private sector,” he said. “The South African business community has an incredibly strong balance sheet [but will not] invest the money given the prevailing low business confidence”. Long story short: government must create an environment in which the private sector is comfortable to unleash the R1.1 trillion that is sitting on their balance sheets. An easy first step will be to work with Business for South Africa (B4SA) to address the triple header of crime and corruption; electricity supply; and transport and logistics.
Writer’s thoughts:
If the South African Reserve Bank (SARB) waits for the US Federal Reserve to cut interest rates, your clients may be waiting until July or August before they get some rate relief. Can your clients survive another half-year with the Repo at 8.25%? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected].
