Argentina shows risk posed by higher US interest rates
Last month the yield on US 10-year treasury bonds rose to above 3% for the first time since 2014. This is an important reminder that the era of very low interest rates and quantitative easing that followed the 2008 global financial crisis is nearing its end.
The US Federal Reserve has raised interest rates six times since 2015. Further increases are expected in 2018 and 2019 because interest rates are much lower than historical norms. The 10-year bond yield was typically 4%-5% prior to the financial crisis. It is likely to take some time before pre-crisis levels are reached, as central banks are still nervous about possible negative impacts on economic recovery if interest rates rise too rapidly.
Why does a rise in US interest rates matter for South Africans? The good news is the Fed is raising rates because it is increasingly confident growth in the US economy is now sustainable. The IMF recently forecast that the US would grow 2.9% in 2018 and 2.7% in 2019. This is much faster than its forecasts six months ago.
Faster US growth stimulates growth elsewhere, including SA. It increases demand for our export commodities such as platinum, iron ore and coal, lifting their prices. It also provides a growing market for other products we export. But stronger US and global growth has also raised oil prices.
A possible negative effect of higher US rates is that global stock markets could weaken. Pension funds may prefer the guaranteed return of more than 3% that will now be earned on bonds, rather than the uncertain gains in what many fear are already overpriced equities.
Weaker global stock markets would spill over to SA, curbing foreigners’ willingness to buy our equities. Overseas interest in our government bonds will weaken because of improved yields elsewhere. We rely heavily on foreign purchases of our equities and bonds to fund monthly deficits on the current account of the balance of payments. The rand will weaken if foreign investors move to more attractive investments elsewhere. This is why emerging market currencies, including the rand, have weakened recently.
Some have asked whether higher global interest rates may spark a new emerging market crisis. Fortunately, they have concluded the risks are quite low, because most developing countries had not borrowed heavily even when interest rates were unusually low.
Nonetheless, the plunge of Argentina’s currency — nearly 10% in two days — is a spectacular illustration of the risk higher US interest rates pose for countries reliant on foreign capital inflows. The central bank has been forced to hike interest rates dramatically.
Higher global rates will make our central bank cautious about reducing interest rates, even though inflation has fallen. The South African Reserve Bank is concerned about the potential effect of lower rates on SA’s ability to attract badly needed foreign inflows. Adding to this concern is how even the very modest signs of improving local growth seem to be translating into substantial increases in imports, making us even more dependent on foreign investment inflows.
Clearly, we cannot rely on growing domestic consumption through borrowing to boost local growth. We must instead try to turn stronger global growth to our advantage by increasing exports. Selling more South African goods in foreign markets will grow the economy and at the same time reduce reliance on what is going to become scarcer foreign capital.
This means we cannot afford to miss out again on the export opportunities. The commodity boom of 2003-10 largely passed us by because inefficient application of mining regulations, inadequate electricity supplies and lack of railway transport prevented our mines from expanding. The country lost out economically, forgoing what would have been much-needed income every year since then.
We also need to diversify exports, but this can only happen when business has confidence. The government therefore needs to continue nurturing the emerging positive signals from the economic base. And businesses need to reciprocate with the courage to translate that improving confidence by investing more in their productive activities for the long-term advantage of us all.
CENTRAL BANKS ARE STILL NERVOUS ABOUT POSSIBLE NEGATIVE IMPACTS ON ECONOMIC RECOVERY IF INTEREST RATES RISE TOO RAPIDLY WE CANNOT AFFORD TO MISS OUT AGAIN ON THE EXPORT OPPORTUNITIES. THE COMMODITY BOOM OF 2003-10 LARGELY PASSED US BY