May was a terrible month for riskier assets. The escalation of the US-China trade conflict has increased the likelihood of a downgrade to the 2020 global economic growth estimates; leading to a sell-off in riskier assets. Three months ago, investors thought that there was a 1% chance that the US Fed will cut interest rates in 2019. Today, investors believe that there is a 64% chance of the US monetary policy authorities cutting interest rates by at least 25 basis points. This change in view has led to bonds (both domestic and global) outperforming equities and cash over the last 3 months. Generally, global economic growth conditions have worsened since the beginning of the year, and in response, global monetary policy authorities have begun adopting a more accommodative stance.
In South Africa, the SARB has come under intense pressure to adopt an even more accommodative monetary policy stance, to stimulate economic growth while alleviating the debt service pressures of the state and its SOEs. Lawrence Siegel, Director of Research at the CFA Institute Research Foundation, once made the following observation:
“Between 2008 and 2015…US government debt balances were up 125%, but debt service costs were down 12%. It’s nice to own a central bank!”
From the outside, it looks like a no brainer – using financial repression (low interest rates) to alleviate the country's debt servicing burden while boosting household disposable income. However, we would caution that such an approach does not consider the following aspects:
Firstly, as an emerging market economy, South Africa cannot play the same game as the US. Our inflation is structurally higher, and we need foreign capital inflows to maintain a stable exchange rate. Setting interest rates at an abnormally low level would make it less attractive for investors to invest in SA, opening us up to the risk of capital flight, significant currency depreciation, and subsequently, higher inflation. The IMF has also alluded to the fact that the playing field with regards to modern monetary policy is uneven and emerging market economies are at a significant disadvantage relative to systemic, develop
Secondly, various studies have shown that there is little correlation between interest rates and long-term economic growth. Yes, interest rates may work during an emergency, such as during the 2018 global financial crisis. But, sustained economic growth comes from only two things: how many people are working and how productive they are. It is for this reason that many continue to argue that monetary policy is a blunt instrument. The US, with its decade-long period of low interest rates has not achieved the economic growth nirvana that it was hoping for, because low interest rates have not solved the issues of a slowly growing labour force or stagnant productivity. It can be argued that low interest rates simply help authorities to kick the can down the road. The IMF made a similar observation recently noting that "continued accommodative financial conditions will likely facilitate the further buildup of vulnerabilities." Vulnerabilities that present risk to economic growth, such as highly leveraged sovereigns, cannot be solved through low interest rates.
The interest rate debate may seem simple at first glance, but it is nothing but. The good news is that an interest rate cut by the US monetary policy authorities will give the SARB enough flexibility to cut interest rates without creating upside risk to inflation expectations. We don’t have a definite view on the monetary policy stance that should be adopted because we prefer to focus on the key drivers of asset class returns, such as sustainable economic growth and inflation. Regardless of what happens over the coming months, we will manage our portfolios in a risk-controlled manner to minimize the impact of such macro factors on the relative investment returns that we aim to deliver.
Lima Mbeu Investment Managers (Pty) Ltd is an authorised financial services provider in terms of section 8 of the Financial Advisory and Intermediary Act, 2002, FSP number 49018, Registration No 2017/399814/07. This document is for information purposes only. Past performance is not indicative of future performance. The information contained herein is derived from sources which are believed to be reliable. Any opinion expressed herein is based on the presenter’s current analysis and is subject to change. This presentation does not constitute an offer to sell or a solicitation to buy any security. Lima Mbeu has a conflict of interest policy which outlines how conflicts of interest are managed. This policy, as well as additional information about Lima Mbeu’s products, is readily available upon request or on our website: www.limambeu.co.za
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