Early last year, we published a news edition entitled “The year of the vaccine”. Our thesis was that the success (or not) of the vaccine rollouts would determine the timing and extent to which global economies would reopen and normalise. This would, in turn, have a profound impact on the sustainability of the equity market rally since the trough of the Covid-induced crisis. As economies reopened, a cocktail of unprecedented stimulus, pent-up consumer demand, and supply-chain bottlenecks caused US inflation to peak at 6.8%, the highest rate in 40 years.
Hence, towards the end of the year, the debate shifted as to whether this level of inflation would be “transitory” as coined by the Federal Reserve, or more permanent in nature.
At the onset of 2022, a survey conducted by Bloomberg among 50 leading financial institutions across Wall Street and beyond, concluded that investors should get ready for “less of the same” for the year ahead, namely that conditions are likely to remain favourable, but that economic growth and market returns will ease. Importantly, the most frequently cited term in the survey was “inflation”.
While firms are divided on how transitory inflation will ultimately prove, the uncertainty feeds a consensus that one of the biggest known risks to markets this year will be monetary policy missteps and that the margin for error will be fine. In other words, the way the US Fed responds to inflation – and the extent to which rate hikes turn out to be higher than currently priced in by the markets – will be key determinants that will shape the global economy and the returns from different asset classes.
It is a logical follow-on that policy decisions by the Fed and other major central banks will also have a profound impact on emerging markets and their respective asset classes and currencies. Any such impact is likely to hold exaggerated consequences for South Africa and its high beta currency, the rand.
“The Federal Reserve and Congress have systematically taught the American people to trust the government and that caution in spending is harmful to the economy.”
– Ron Paul, American author and retired politician
“Of all the weapons in the Federal Reserve arsenal, words were the most unpredictable in their consequences.”
– John Kenneth Galbraith, Canadian American economist
- Writing for BusinessLive, Chris Gilmour argued that it appears increasingly likely that 2022 will be a year of progressively rising interest rates, not just in the US, but around the world too. At long last, US Federal Reserve chair, Jerome Powell, has come to terms with the realisation that inflation in the US is not necessarily “transitory”. At the last Fed meeting, it was stated unequivocally that interest rates would rise in 2022 and 2023 in response to higher inflation.
- Another barometer of US Federal Reserve hawkishness is making a bigger appearance on investors’ dashboards: quantitative tightening. Minutes from the Fed’s December meeting released on Wednesday showed that officials had discussed shrinking the US central bank’s overall asset holdings as well as raising interest rates sooner than expected to fight inflation, with “many” judging that the appropriate pace of the Fed’s balance sheet reduction would be faster this time.
- More results from the Bloomberg survey include that the expectation is for policy to tighten and yields to rise, and variations of the terms “rising rates” and “higher yields” appear throughout. With bond returns expected to be negative, fixed-income trades veer into ever-more complicated territory, like collateralised loan obligations, which Federated Hermes touts for their “complexity premia”.
- In a departure from 2021, “Covid” gets just 36 mentions in Bloomberg’s selected calls. As BNY Mellon Wealth Management puts it, the hope is that vaccines mean the world is “turning the corner from pandemic to endemic”. The word “China” appeared more than twice as often, with a slowdown in the world’s second-largest economy seen as a major risk. Unpredictable domestic policy out of Beijing was a frequently cited headache, while the likes of Bank of America flag the “extreme downside risk” of a flare up over Taiwan.
- Meanwhile, countless pages were dedicated to environmental, social and governance investing, though specific strategies were hard to come by. Despite a blockbuster year, scant attention was paid to digital assets. In the words of JPMorgan Asset Management: “Despite media hype and sharp price rises, crypto is not yet established as a portfolio asset.”
- On a lighter note, motorists may soon be able to change the colour of their vehicles with the touch of a button. That’s according to BMW which debuted of its concept vehicle, the BMW iX Flow that uses electrophoretic technology to change colours from black to white, combine them in a kaleidoscope of graphics, or change from dark to light while driving in hot climates to help with efficiency and thermal regulation inside the vehicle.
- Within a South African context, the Central Bank has stated that it alone cannot be held responsible for stimulating economic growth and that further structural reform is required. At Dynasty, we continue to remain negative about South African prospects as the government cannot indefinitely rely on the sustainability of the resources boom to subsidise its budget deficits. With a constant demand for money, especially from struggling and dysfunctional municipalities, budgetary constraints will remain a problem, as well as an obstacle to desperately needed upgrades to infrastructure.
- The South African Reserve Bank expects the economy to grow by a mere 1.7% in 2022 and perhaps by 1.8% in 2023. This means the country will lag its developed market peers and endorses our long-held conviction that better and broader opportunities are on offer offshore.
- South Africa’s inflation rate appears to be well-anchored and caused mainly by imported inflation, as demand-pull inflation is virtually non-existent in the languishing local economy. This poses a real dilemma for the SA Reserve Bank. Increasing interest rates to combat rising prices will temper economic growth. Speaking after the last meeting of the MPC in November 2021, governor Lesetja Kganyago said the implied policy rate path of the quarterly projection model suggests further rate increases in each quarter of 2022.
- Other than externally driven factors, local political risk is currently the biggest issue we face, specifically in the lead-up to the ANC electoral conference in December this year, during which the RET faction is likely to escalate its efforts to regain control of the party.
- As a portend to this risk, Parliament was literally set alight on 2 January. It is the State’s contention that a Mr Mafe is the man who started the fire in the precinct that destroyed the National Assembly building. Investigators contend that, on the day of his arrest, Mafe was found with an explosive device and a laptop. Mafe, who lives in Khayelitsha, faces charges of housebreaking with the intent to steal, theft, two counts of arson, possession of an explosive device, and destruction of essential infrastructure.
- In a separate, but related incident, police have arrested a suspect accused of using a hammer to destroy the glass doors and windows of the Constitutional Court in Johannesburg on Wednesday morning. The main entrance to the Constitutional Court was littered with shattered glass following the attack. This criminality came in the wake of Judge Raymond Zondo’s State Capture Report to President Cyril Ramaphosa earlier this week. Judge Zonda also currently serves as acting Chief Justice of the country.
- Repeated attacks of this nature aimed at the country’s governing institutions are likely to be construed as a form of terrorism, thereby further undermining political stability and business confidence.
Sources: Dynasty, Bloomberg, BusinessLive, IOL, Business insider, Daily Maverick, EWN, BBC, Daily Maverick, etc.