‘New dawn’ faces global challenges too
When the US Federal Reserve changed its interest rate policy guidance in favour of data dependence at its January meeting, it established a new pivot for the macroeconomic and financial markets outlook for 2019.
Fed funds rates are pricing in only a 7% probability of one rate hike and 18% probability of more than one by the first quarter of 2020. As a result, the US dollar is now expected to weaken, which by implication means emerging-market currencies are expected to strengthen against the greenback. Historically, a weaker US dollar has been associated with stable inflation, fewer interest rate hikes by global central banks, improved commodity prices, a recovery in equities and emergingmarket growth outperforming that of advanced economies.
This would be the perfect global backdrop for SA’s macroeconomic policy setting and investment outlook, but there are several macroeconomic risks that both local policymakers and investors need to seriously consider for the next 12 to 24 months. This sudden change in market outlook after negative returns in almost all asset classes in 2018 the exceptions being cash, bonds and some alternative asset classes is driven by the change in the Fed interest rate outlook.
A little detour is warranted to answer the question of why many investors saw their portfolio returns turn negative in 2018. As long as your fund manager ran a diversified or balanced portfolio of some sort, it didn’t matter which asset classes they were invested in, they would have ended 2018 with negative returns because the majority of asset classes returns were negative.
Why did the Fed abruptly change course? There are two possible reasons, with completely different macroeconomic and market implications. First, the Fed was possibly concerned about the slowdown in US growth and stopped raising interest rates to stop the slowdown. This would tie in with a supportive backdrop for emerging markets like SA as it revives risk appetite and capital inflows.
Second, the Fed possibly saw signs of a pending US recession and backtracked on tightening rates without sounding any alarms. If this is the case, the Fed is already late as rates peak when economies are already headed for recession. This is the view conveyed by David Rosenberg, chief economist at Gluskin Sheff and Associates, at Rand Merchant Bank’s Global Markets seminar.
He stated unequivocally that the US will fall into recession in 2019, citing indicators such as the inversion of the US yield curve, expectations of earnings recession, correction in equity markets and a trough in US unemployment, which is usually followed by recession.
While the evidence provided is compelling, the timing may well be 2020 instead of 2019.
There are other risks that could make 2019 go wrong for SA’s macroeconomic configuration and investment outlook. The probability of a nodeal Brexit come March 29 has been rising. If a hard Brexit occurs, SA will see reduced trade and foreign direct investment inflows, and financial markets will be negatively affected.
SA assets are highly correlated to China’s economic growth, commodities prices and the S&P 500. China’s growth is forecast to slow down, which means there will be a second-round effect through depressed commodity prices. Earnings estimates for the S&P 500 are now in negative territory, which usually implies negative equity markets all round.
These risks imply that President Cyril Ramaphosa’s radical economic reform agenda has a lot of dependencies that are outside the control of any South African. For investors, the risks necessitate slowly taking defensive positions, instead of trying to chase returns in an uncertain environment.
The last risk, perhaps the most important one, is the outcome of SA’s elections on May 8. For structural economic reforms to take place, Ramaphosa must win a strong majority at the polls. Failure to do so will plunge the country into coalition politics, which could see the “new dawn” being stillborn. Given the global risks, there will be little to cushion local markets in the event of any of the several risks manifesting.