Speaker 0:
joining me now for the mid year outlook. Isa macro strategist at Old Mutual Multi managers. Welcome back is a So is a The Fed has recently decided to leave interest rates unchanged after 10 consecutive rate hikes. What signals is, is this sending out into the global economy? And how does it affect South Africa's monetary and fiscal stance?

Speaker 1:
Yeah, so the first question is, Is the Fed done? Um and and I don't think they are necessarily done.

Speaker 1:
Um, I think they've just paused to kind of assess the impact of of interest rates on the US economy and US inflation rates up till now. And remember that that impact always takes time to philtre through, um, interest rates always work. Work with the lag. I mean, the big problem is that inflation is still, Although it's come down, inflation is still elevated. It's still well above where they want to see it. So, um,

Speaker 1:
yeah, I don't think it's a given that they've stopped hiking, but let's say they are much closer to the end than they are to the start. We we are in that territory more or less where where they will, where they will peak. Now, the impact on on global markets is obviously massive. You know, this is the interest rate that sets the tone for pretty much every asset class globally. Um, so So the expectation that we close to the end of the hiking cycle, I think is very important for for financial markets. If it this is not the end, then you're going to see,

Speaker 1:
um I think quite a negative impact on on global bond and equity markets. Um, in terms of South Africa, I think the the the key thing is that again, we cannot ignore what happens in America. Right? So you've seen the South African Reserve Bank hike interest rates probably much more than they would have otherwise, given the fact that the the US interest rates have increased, um,

Speaker 1:
quite a lot. And I think it's I think it's important to note that for all these central banks, so South Africa, the US, the UK, all of them interest rates are much higher than was thought would be the case. You know, three months ago, six months ago, nine months ago. So there's been been a continuous ratcheting up of interest rates and interest rate expectations. So

Speaker 0:
then, with um, interest rates peaking globally, how long are they expected to stay so high? And why is global inflation then proving to be a little bit more stubborn?

Speaker 1:
Yeah, So I think I think the second part of the question is key. I mean, as long as inflation remains stubborn, interest rates will have to will have to remain high. So why is inflation stubborn? I think inflation is no longer a case of commodity prices or food prices, as we saw last year. I mean, that's pretty much come through the the year on year numbers. That's washing out of the out of the numbers. I think it's now. The main story is that you have in in all developed countries. You have a very low unemployment rates.

Speaker 1:
That means, uh, people have jobs. Jobs are being created, uh, wages are rising, so there's lots of spending power. You know, there's money to spend, and that is sustaining sustaining high prices. Um, and that's something that's coming that comes through in the commentary of all the central banks is you know, our wage rates are too high. Our labour markets are too tight. Um, so part of the story of getting inflation under control is to have a situation where wages aren't rising as much and there's a bit more looseness in in in labour markets.

Speaker 1:
Um, we're not there yet Clearly, Um, and that means, in other words, that interest rates will probably remain at these levels or slightly higher, I think, for for quite a bit of time. So if you just use the US as an example, um, you know, until very recently the market was pricing in interest rate cuts later this year, and I think that is that is now completely off the table.

Speaker 1:
Rates are probably going to rise and then stay there for at least the remainder of the year, uh, possibly into into next year. Depending, of course, on how the economic, uh, outlook unfolds.

Speaker 0:
So it seems as though a recession seems to be the word on the street, particularly, um, now, with South Africa having a near miss now, most recently, is the aggressive monetary tightening likely to cause a recession locally in South Africa.

Speaker 1:
Yeah, I think in South Africa the situation is obviously very different to the rest of the world because in the rest of the world, you've got pretty strong economic growth. As I said, low unemployment, you know, things are actually, despite the high interest rates, despite the high inflation, things are actually going pretty well. And therefore, the fear is that you know, you're gonna run into a wall basically, um, which is a recession

Speaker 1:
in South Africa because you have such low growth rates because we have such high unemployment already. Um, recession is almost a meaningless term

Speaker 1:
because because, you know, we we kind of crawling along along anyway, it's It's not as if it's going to be a major shock if we do experience a few quarters of negative growth. I think the bigger problem in South Africa is not the risk of a recession, as is the case in the US where you would go from a relatively high pace of growth to suddenly, uh, suddenly declining. I think in the case of South Africa is you know, are we going to be stuck in this low growth environment permanently, or is there something that's gonna get us out of this low growth environment? Um, and I think we all know that the big challenge is is electricity.

Speaker 1:
It's load shedding, you know. And there at least we can say that things are moving in the right direction in terms of private energy generation, all these big renewable projects coming on stream. So I think they

Speaker 1:
you know, there's a There's a positive outlook, even though in the very short term things are still quite, uh, quite murky. Um, but, yeah, you have to say that on the consumer side is where you want to be want to be worried Because as much as we focus on load shedding a big part of the economic

Speaker 1:
picture in South Africa still consumer spending it still about 60% of GDP. So you have to say it. Higher interest rates, uh, high inflation. You know, these things have put a squeeze on consumer spending.

Speaker 1:
Um, and certainly the next the next while will be tough, but I think you know, at least inflation is now coming down. So you are going to see a bit of an increase in real income for South African households, you know, as we head into next year. So I think we in South Africa, we kind of toughing out and things should get a bit better towards, uh towards next year. OK,

Speaker 0:
so there's

Speaker 0:
are some unique risks that South Africa faces. Um, particularly now surrounding load shedding. Um, how has load shedding, uh, affected the growth outlook for the South African

Speaker 1:
economy? It's been massive, right? So at the start of the year, I think the consensus growth forecast for South Africa was 1%. Plus, um, now it's basically zero

Speaker 1:
so and that's mainly because of load shedding. Um,

Speaker 1:
now I think it's very difficult to forecast how load shedding impacts the economy because businesses are continuously adapting, uh, to load shedding. We've seen record imports of lithium batteries, record imports of, um, solar panels, and by record, I mean more this year than in all previous years combined. So So So there is a big you know, the the economy businesses. Households are adapting. So that's the one thing Number two, of course, load shedding jumps around from day to day and week to week.

Speaker 1:
So it's very difficult to know now what's gonna be, you know, the load load shedding schedule for the next six months. You know that that is, that is quite variable, but there's no doubt that it's had a big impact on the economy on confidence. It's had a big impact on financial markets as well. That big decline that we saw in the rand in May, I think, was in large part because of the fear that suddenly, uh, the economy might come to a complete standstill if we hit stage six. Sorry, Stage eight. Load shedding. Um, thankfully, as we speak today, that seems to be less likely. But, you know,

Speaker 1:
it's uncertain.

Speaker 0:
No, certainly. So, um, it's like I'd like to understand, with all this monetary tightening taking place, Um, what effect has this had on our currency and particularly surrounding imports and exports?

Speaker 1:
Yeah. So the big thing has been again you you know, currency is always in a global context. It's not just what happens in South Africa, it's what happens elsewhere. So, yes, our interest rates have gone up, but US interest rates have also gone up a lot. Um, that has had the effect of strengthening the dollar against all currencies

Speaker 1:
for most of the last few years. Um, so you've seen a weak rand and a strong dollar up until about late last year. Since then the rand has really been on its own. You've seen other emerging market currencies strengthen. You've seen the dollar pulling back. Um, and I think that really is South Africa. Specific issues around load shedding. And and and, uh, you know, all the S a idiosyncratic risks.

Speaker 1:
Um, in theory, as the Reserve bank raises interest rates, that should make the rand more attractive, and that should kind of help the rand stabilise, and and and perhaps that's what we've seen over the last few weeks, I think what

Speaker 1:
What we should note, though, is that South African interest rates have not gone up as much as some of our peer group. So if you look at Brazil, for instance, their interest rate went all the way from 2% to 13% in this cycle. And you had a similar story in Chile. You had a similar story, Um, in Eastern Europe and all you know, across across Latin America. So

Speaker 1:
we went from having one of the higher interest rates, short term interest rates in emerging markets to now where we have, um, we sort of middle of the pack and and therefore I don't think you've seen the big support for the rand coming from from higher interest rates. But on the other hand, we don't know how bad it would have been if the Reserve Bank didn't hike interest rates. Maybe the rand would have been at 22 23 against the dollar.

Speaker 0:
So it's like now moving over to the East China. OK, so China has been taking economic action pretty much inversely to what the rest of the world has been doing. Has this presented any opportunities for you?

Speaker 1:
It's presented a lot of questions,

Speaker 1:
so yeah, so China has gone completely the opposite direction. Firstly with their lockdowns, when the rest of the world is reopening, they were tightening the lockdowns and then, um as the rest of the world was hiking interest rates. Their interest rates have been actually falling. Inflation is very low in China. It's kind of hovering near 0%. The rest of the world is obviously still very elevated and, um,

Speaker 1:
central banks are still tightening policy as we said said earlier, So China is in a very different moment, cyclically to the rest of the world. I think the concern is also that there's a structural issue now that China, after many years of rapid economic growth after many years of a booming property sector, many years of being the major, uh um, manufacturing hub for the world that you've now run out of road in terms of those structural drivers, you know? So the property sector, I think that bubble has burst

Speaker 1:
in terms of its labour force obviously is starting to contract. Um, so it's got a pretty poor demographic outlook. And in terms of the manufacturing story you're seeing rearing, you're seeing a lot of companies kind of redirecting their supply chains out of China. So I think it's a very uncertain It's a very uncertain time. Um, for for the Chinese economy, I think what you're going to see in the next couple of months is more policy announcements to try and support that economy. Um, I don't think they're gonna go for kind of the big, big bazooka kind of approach is stimulating the economy that we saw

Speaker 1:
over the last 10 years of previous episodes. I think it's gonna be much more targeted because they also sit with huge imbalances, big debt problems. They don't want to worsen any of that.

Speaker 0:
So now, considering all the the macroeconomic backdrop that we've now spoken about, what are market valuations looking like? And how is this informing your asset allocations?

Speaker 1:
Yeah, I think things are things are very uncertain. So So, uh, but they're always uncertain. So I think as investors, the question you wanna ask yourself is not whether things are uncertain. It's, you know, Am I being paid to take on risk? Uh, conversely, what is the opportunity cost to being defensive? So So you know, the first part of the question am I paid to to take on risk? You know, what are equity valuations looking like,

Speaker 1:
um, in places like South Africa? A lot of risk, A lot of uncertainty. But you have, you know, a four PE ratio of nine times. Um so I think there you are being paid to take on risk, and you can say the same about you know, other emerging markets. You can the same about, um, European equities.

Speaker 1:
More or less, um, on the U SI think. You know, you look at where markets are being priced and you say I'm not really being paid to take to take on this risk. Um, so I think that that is how you're gonna think about about equities in this world. And then the flip side is you know what? What is the cost of being defensive? Um, what am I missing out on if I'm sitting in cash and obviously with interest rates having gone up so much, the the the opportunity cost of being a bit more defensive of keeping some dry powder, Um,

Speaker 1:
and being selective in where you deploy money that opportunity cost has actually declined because you can now get, you know, 5% cash returns in the US, 8% in South Africa. Even in Europe, you've gone from negative interest rates to now positive interest rates. I think I think that whole picture has changed quite a lot in the in the in the short term cash markets in global bonds, um, still opportunities and and obviously in South African South African bond market again,

Speaker 1:
um, lots of risks, lots of uncertainty around fiscal situation. But you you know, you've got a real yield of, you know, 5 6% in the bond market. It's very hard to ignore that.

Speaker 0:
OK, so it's like now just to close up the session. There's one question that I want to ask you. What risks are you monitoring very closely going ahead into the second half of this

Speaker 1:
year? Yeah. So I think the key thing locally is is is load shedding, right? So So I think it's gonna be better than expected or or worse than expected. Um, bearing in mind that expectations are very low. Expectations are, you know, stage eight load shedding or something similar. So if it it's a little bit better than that,

Speaker 1:
I think you'll see South African markets respond positively. And I think you'll see the South African economy doing better than maybe the consensus expects. I think internationally, the big question is, you know, is the US economy going to maintain this positive momentum? And is that going to force the Fed into hiking interest rates more than currently expected?

Speaker 1:
Because I think that will have quite a negative impact on markets if we get to a point where you know, a few months down the line, the Fed says we're still not stopping interest rates, and we're gonna take interest rates, you know, into the sort of the, um I think that would be AAA. Pretty negative. Um, outcome.

Speaker 0:
Thank you very much for sharing your insights into the major outlook. We appreciate your time.