Light at the end of the tunnel

The FOMC exhibits heightened data dependence

A heightened emphasis on “data dependence” by the Federal Open Market Committee (FOMC) members in recent months highlights the prevailing uncertainly on the near-term inflation path. As expected, committee members voted to retain a Fed Funds target range of 5.25% - 5.50% at their May policy meeting. However, despite the stickiness in consumer prices, Chairman Jerome Powel’s statement highlighted the high hurdle to further interest rate hikes occurring in this cycle, quelling fears from some quarters that further hikes might be necessary. Outsized consumer savings have coincided with the stickiness in consumer prices in recent years – indications that these savings have now been depleted lays the grounds for moderating consumer spending and an eventual slow and shallow interest rate cutting cycle.

Figure 1: US Phillips Curve

Source: Bloomberg, Futuregrowth

The European Central Bank Governing Council has an altogether finer balance to strike between edging inflation outcomes back towards its 2% target while not completely throttling aggregate economic growth. We expect that interest rate cuts at the June policy meeting will be actively discussed and voted on by committee members. The People’s Bank of China, on the other hand, remains vigilant to the threat of disinflationary consumer prices and their effect on spending and macroeconomic growth if sustained.

Domestic CPI remains elevated and sticky

Domestic headline consumer price inflation (CPI) remained elevated and sticky in March at 5.3% year on year, softening marginally relative to the 5.6% recorded in February on account of lower food inflation. Core inflation, which had trended upwards in recent months, receded to 4.9% year on year in March from 5.0% in February. The month-on-month change in the seasonally adjusted consumer price index also edged lower in March. This measure avoids the annual base effects inherent in annual CPI measures and gives a truer reflection of the latest price momentum. Producer Price Inflation, which measures inflation on final manufactured goods, marginally exceeded expectations by growing at 4.6% year on year in March relative to 4.5% in February.

Notwithstanding early evidence of abating consumer price pressures, we assess the medium-term forecast risk to headline inflation to be to the upside, primarily due to the El Niño weather pattern and the related cuts to expected maize harvests. Energy price pressures and potential rand weakness also raise forecast risk.

The volatility in forward rate agreement (FRA) rates, which until recently were pricing interest rate hikes, points to market uncertainty on the near-term path of domestic interest rates. We remain of the view that the nominal repo rate has peaked at 8.25% in the current interest rate cycle. Despite the already elevated real rate environment, the South African Reserve Bank (SARB) will remain hawkish until convinced that domestic consumer price inflation has moved sustainably towards the 4.5% year-on-year midpoint of the inflation target band. We think that this comfort can be reached in the third or fourth quarter of 2024, allowing for a shallow and gradual interest rate cutting cycle.

Figure 2: RSA Forward Rate Agreement (FRA) Rates

Source: Bloomberg, Futuregrowth

The loadshedding constraint on the economy eases

Mining production grew by 9.9% year on year in February, significantly improved from the 2.8% recorded in January. February’s growth was led by a 42.1% year-on-year increase in iron ore production and a 14.6% rise in coal production. Eight of the twelve mining subsectors recorded positive year-on-year growth rates. Manufacturing production was also strong in February, growing at 4.1% year on year. While too soon to draw clear parallels, it’s noteworthy that the broad-based improvement in mining and manufacturing production has coincided with the suspension of loadshedding, improved energy availability and reduced congestion at national ports.

Consumer readings painted a mixed picture in February, with wholesale and retail trade gaining in year-on-year terms, but passenger vehicle sales remaining sluggish. Household credit growth also relapsed in March, slowing to 3.7% year on year relative to 4.1% in February. While aggregate private sector credit extension spiked to 5.2% year on year in March, growth remained weak in real terms – and will remain a continued headwind to aggregate economic growth with monetary policy anchored in restrictive territory. Credit lending standards have not been key determinants of monetary policy in the current hiking cycle, but they nonetheless highlight the weakness of aggregated demand (particularly for households) and will lend support to the arguments for monetary policy easing in the second half of 2024.

The grounds are laid for a change in fiscal fortunes

The 2023/24 fiscal year closed in March, and confirmed earlier indications of a marginal improvement in fiscal outcomes. The fiscal deficit narrowed to 4.6% of Gross Domestic Product (GDP) in the period, relative to the 4.7% tabled in the national budget in February. This improvement on expectations was supported by both expenditure constraint (against our expectations in an election year) and revenue outperformance – the hallmark of an increasingly capacitated and efficient revenue service. The expenditure outperformance is particularly commendable, with spending having exceeded our fiscal year-to-date estimates by 0.2% - 0.3% for the greater part of the year.

Fiscal flexibility remains a constraint for government finances in the medium term, as is weak macroeconomic growth. In our estimation, based on the current fiscal framework, debt sustainability will only be achieved with real GDP growth on approach of 3% per annum – a low water mark in an emerging market context yet meaningfully removed from South Africa’s trend growth rate of 1% - 2% in the past decade. Despite this, provided broad policy continuity persists following the upcoming national election, we think we have seen the worst of the erosion in fiscal finances in recent years, with an attainable medium-term expenditure framework (MTEF) tabled by National Treasury in the February budget.

Commissioner Edward Kieswetter’s leadership of the South African Revenue Service (SARS) has also ushered in a period of improved tax compliance and revenue buoyancy. The recent announcement of the extension of his leadership tenure by a further two years will allow for an orderly transition and provides great hope that the recent gains will be sustained.

Figure 3: RSA Main Budget Balance

Source: National Treasury, Futuregrowth

Long-dated nominal bonds feel some reprieve

The domestic nominal yield curve bull flattened in April, driven by improved risk appetite by local and foreign market participants. ALBI +12 years was the best performing segment of the nominal bond curve, rendering a total return of 2.31% relative to the ALBI total return of 1.37%. Cash, proxied by the SteFI Call Deposit Index, rendered a return of 0.65% for the month, with the IGOV Index, comprised of sovereign issued local currency inflation-linked bonds (ILBs), rendering a return of 0.24%.

Figure 4: Bond market index returns (periods ending 30 April 2024)

Source: IRESS, Futuregrowth

/// THE TAKEOUT: A heightened emphasis on “data dependence” by FOMC members in recent months highlights the prevailing uncertainly on the near-term inflation path. Despite the stickiness in consumer prices, Jerome Powel’s May FOMC statement highlighted the high hurdle to further interest rate hikes in this cycle, quelling fears from some quarters that further hikes might be necessary in this cycle. The European Central Bank Governing Council has an altogether finer balance to strike in monetary policy management. We expect that interest rate cuts at the June policy meeting will be actively discussed and voted on by committee members. Domestically, notwithstanding early evidence of abating consumer price pressures, we assess the medium-term forecast risk to headline inflation to be to the upside. While the FRA market continues to price marginal further hikes, we remain of the view that the nominal repo rate has peaked at 8.25% in the current interest rate cycle and we continue to expect a modest interest rate cutting cycle to commence in the second half of 2024.