Our first newsletter for 2022, titled The Year of the Fed, outlined why we felt the US Federal Reserve’s reactions to persistent inflation would be the key determining factor in how markets faired this year. What we didn’t know was that their job would become that much harder as inflation had another, and perhaps more pronounced, leg-up coming from the Russian war on Ukraine.
Federal Reserve chair Jerome Powell was clarifying and defending their approach during his semi-annual, two-day testimony to US Congress this week. The key take outs were that the Fed’s strategy of bringing inflation under control is “unconditional”; that the Fed is not prepared to revise its inflation target up from 2%; that the instruments at its disposal are “blunt”; and that, while a recession may occur as a result of their actions, it is by no means inevitable. He reiterated that the US economy is robust and that an increase in unemployment from the current levels of 3.6% to as much as 4.2% would not be too detrimental.
We note that the primary “blunt’ tool available to all central banks is the level of interest rates and they’re almost all moving in the same direction in their quests, even though each underlying economy is in a very different position.
As mentioned, the US economy is currently healthy and close to full employment, while the UK, for example, is “running on empty” according to economic reports this week. The South African Reserve Bank is purportedly considering mimicking the Fed by raising rates a further 0.75% in response to inflation breaching the 6% upper level of its target range at 6.5% this week – despite the fact that the official SA unemployment rate at 34.5% is almost ten times higher than that of the US.
We’re therefore highlighting that, while many global economies are in the same boat when it comes to inflation dilemmas, their destinations may be quite different. It is for this reason that we continue to favour predominantly US-listed, globally diversified equity exposure over local.
“It’s only when the tide goes out that you discover who’s been swimming naked.”
– Warren Buffett, American business magnate and investor
- Federal Reserve chairman Jerome Powell has warned that steep interest rate hikes could potentially see the US entering a recession, echoing what many have already warned about. However, the country faces the risk of prices spiralling out of control if inflation is not brought in check.
- According to CitiGroup, the probability of the world economy succumbing to a recession is nearing 50% as central banks tighten monetary policy and the demand for goods weakens. Supply shocks continue to push up inflation and drive down growth, leading to increased interest rates that will throttle spending. As we noted last week, however, a recession may already be priced into global equity market levels.
- This comes as UK inflation hit a fresh four-decade high in May at 9.1% year-on-year after broad increases in the cost of everything from fuel and electricity to food and beverages. According to Chris Williamson, chief business economist at S&P Global Market Intelligence, “The economy is starting to look like it is running on empty. Business confidence has now slumped to a level, which has in the past typically signalled an imminent recession.”
- In Europe, Germany will be restarting coal-fired power plants to conserve natural gas amid concerns of a looming supply shortage. This after Russia cut gas deliveries to Europe, which is currently taking measures to deal with reduced energy supplies.
- Oil, a major inflation driver, has dropped along with other key commodities as concern over a global economic slowdown intensified. West Texas Intermediate sank to $103 a barrel after closing at a six-week low on Wednesday. Gold had also slipped slightly to $1 824.
- Israel is heading for its fifth election in under four years as the fractious ruling coalition headed by Prime Minister Naftali Bennett has collapsed after a series of internal disputes. Senior officials have decided to dissolve parliament with a caretaker being put in place ahead of elections set to be held on 25 October.
- As of Thursday’s close, the S&P 500 was up 3.3% for the week, with the futures suggesting an even stronger close to the week.
- Writing for Business Day, Ricardo Smith, chief investment officer at Absa Stockbrokers, says the MPC was initially more proactive in its interest rate normalisation as the economy recovered from the Covid-19 pandemic, hiking interest rates twice by 25bps each time, even before the Fed touched rates. One would therefore expect a cushion from the more aggressive policy normalisation in the US. However, this has not been the case as the MPC has mimicked every rate hike by the Fed since. Furthermore, criticism has been levelled against it as inflation in SA has only recently been moderately above the 6% target and is largely driven by supply-side shortages rather than demand-side factors, unlike the US where inflation is broad-based and significantly above the Fed’s 2% target.
- Annual consumer price inflation quickened to 6.5% in May from 5.9% in April and March, breaking through the upper limit of the SA Reserve Bank’s monetary policy target range. This is the highest reading since January 2017 when the rate was 6.6%. As a result, the Reserve Bank is likely to continue hiking interest rates, following similar moves by other countries. In fact, the borrowing rate this year may be hiked by the biggest margin in almost two decades.
- Chief Justice Raymond Zondo, chair of the state capture inquiry, has blasted president Cyril Ramaphosa over his silence and inaction regarding systematic political corruption. This follows the release of the fourth instalment of reports from the Judicial Commission of Inquiry into Allegations of State Capture, Corruption and Fraud in the Public Sector.
- The official opposition, the DA, has stepped into the fray, requesting the US Federal Bureau of Investigation to investigate president Ramaphosa for money laundering.
- Auditor-general Tsakani Maluleke has released a hard-hitting report that has detailed the story of South Africa’s economic decline, which is effectively a story of municipal decay. It shows the country has a hapless national government that has shown little appetite for oversight, which has seen the putrefaction of municipalities – the engine rooms of any bottom-up economy. This follows news of the theft of millions in forex from president Ramaphosa’s farm at a time when he is, ironically, trying to clamp down on corruption. We have been concerned for some time about the impact that the situation at the municipalities will have on service delivery and the fiscus.
- This comes as columnist Justice Malala argues that insurrection warning lights are flashing again. “With two weeks to go to the anniversary of the riots [that devastated parts of KwaZulu-Natal last year], I fear we may be on the verge of a similar uprising. All the elements that existed at that point in South Africa can be seen today. All the signals that the intelligence agencies should have heeded last year are sharply visible today. I pray, again, that I am wrong.”
- Meanwhile, South Africa’s $8.5 billion climate agreement with several EU countries may draw new partners as the president of the COP26 climate talks, Alok Sharma, said other nations and philanthropic organisations want to join the climate finance deal offered to South Africa by the UK, the US, Germany, France, and the European Union. That could increase the amount of money South Africa will receive to help the nation transition away from coal.
- However, South Africa’s plan to build large-scale, gas-fired power plants as it makes the transition away from coal, are outdated with renewable technologies becoming cheaper and pressure mounting to curb its carbon emissions, according to a Meridian Economics study. South Africa, the world’s 13th biggest source of greenhouse gases, will need to spend $250 billion over the next three decades to close its coal-fired power plants and replace them with green energy.
- Tech giant Amazon is, according to leaked documents seen by Business Insider, planning to introduce an online marketplace in South Africa as part of a global expansion this year. Locally, this will see it going up against established Takealot. Amazon is targeting at least five new territories in the coming year, including Belgium, Chile, Colombia, Nigeria, and South Africa.
- At the time of writing, the JSE ALSI was up 0.73% for the week, while the rand was trading 0.74% stronger against the US dollar.
Sources: Dynasty, BusinessLive, Bloomberg, The Economist, Reuters, Business Insider, BusinessTech, Moneyweb, etc.