Don’t bank on interest rates coming down

Henk Kotze, Portfolio Manager at Prescient Investment Management

Uncertain times call for a measured approach to risk: Prescient Investment Management

If the SA Reserve Bank is serious about anchoring inflation around the midpoint of the inflation target range of 3% to 6%, its Monetary Policy Committee is unlikely to cut interest rates this year.

That’s the view of Henk Kotze, portfolio manager in the interest-bearing team at Prescient Investment Management: “The central bank has stated its desire to see inflation expectations move closer to the midpoint of the target range to create more monetary policy flexibility within the range.

“While the inflation figure for December 2018 came in at the mid-point of 4.5%, easing from 5.2% in November, our view is that the consumer price index has upside risk from here. With the maize price, oil, electricity prices and wage demands all adding to inflationary pressures, cutting rates would be difficult now given the monetary policy objective.”

Kotze added that various macro factors support the case for maintaining interest rates.

“In terms of fiscal policy, the Budget in February will be telling with the deficit number potentially being worse than what was tabled in the Medium-Term Budget Policy Statement (MTBPS)”.

“Eskom will also be a drag on growth due to load shedding, with a government bail-out of Eskom adding to the pressure on the fiscus.

It’s important to acknowledge that South Africa’s growth problem is not because of high interest rates, meaning that cutting rates would not necessarily be conducive to stimulating growth. Instead, structural, policy uncertainty and confidence issues need to be addressed.

Kotze argues that cutting rates in this scenario would make South Africa less competitive in the emerging market complex, something the country can’t afford given the need for portfolio inflows.

He says the South African market priced in a slight probability of a rate cut during January, driven by the US where the Federal Reserve has paused rate hikes, taking its foot off of the pedal with a more dovish stance. Currently the market is pricing for flat rates this year.

Last month, in response to decelerating global growth and uncertain trade policies, the Fed ditched its earlier guidance signaling further rate increases.

Data watchers point to a healthy US economy, with low unemployment and perhaps some risk to inflation from wage growth that could cause the Fed to move again on interest rates. However, the market in the US is currently pricing for rate cuts, which could be premature.

Interest rates play a central role in positioning investment portfolios for optimal growth, making an asset manager’s house view on this metric an important consideration. In this context, Kotze notes that the real returns achieved in the South African fixed income market is attractive and achievable with limited risk.

Having developed its tried and tested process over the past 20 years, fixed income markets are one of Prescient Investment Management’s strengths.

“These uncertain times call for a measured allocation to risk,” says Kotze.