Focus on near-term growth and vaccines
In its latest World Economic Outlook report, Managing Divergent Recoveries, the IMF says that “multispeed recoveries could pose financial risks if interest rates in the US rise further”. They could cause “inflated asset valuations to unwind in a disorderly manner, financial conditions to tighten sharply, and recovery prospects to deteriorate, especially for some highly leveraged emerging markets and developing economies”.
This is a better articulation of the point I was trying to make in my most recent Business Day piece (“Bank should not wait too long before normalising rates”, March 30). Policymakers need to worry about where their countries are in economic recovery relative to the US because for good or ill US policy decisions set global monetary conditions. Countries that lag the US in economic recovery might end up with monetary policy settings that are unsuitable for their economic environment.
Federal Reserve Bank of St Louis president and US Fed market open committee member James Bullard told Bloomberg that getting about 75% of the US population vaccinated would signal Covid19 crisis was ending and maybe open the way for a taper debate. According to the Financial Times’s Covid-19 vaccine tracker, the US vaccinated 22.1% of its people by April 10. SA had vaccinated 0.5% of its people.
If the Fed starts to talk about tapering its bond purchases, real rates will rise globally. Rising real rates are not a problem if growth is strong, but would be challenging in economies still hobbled by the effects of Covid-19. The spectre of tapering before economies have fully reopened should be one of the gravest concerns for emerging markets everywhere.
Financial markets are trying to digest the possibility of misalignment in financial conditions between the US and everyone else. In February, SA’s Treasury unveiled a budget that was better than that announced in the medium-term budget policy statement and what the market had expected. Even then, bond yields rose and the expected fall in government borrowing costs did not occur.
Foreign investors continued to sell domestic bonds in March. The deterioration in global borrowing costs offset the positive effect of domestic policy decisions, much to everyone’s disappointment. SA
bonds are now at extremely cheap levels, but this does not seem to be attracting buying interest. Things would possibly have been much worse had the Treasury not adopted the stance it did, which makes the outcome still net positive.
But the message remains clear: as the tide of liquidity becomes more questionable, risk premiums rise and the costs of borrowing become stickier to the upside. To offset this dynamic, countries need to demonstrate an improvement in growth prospects to attract capital. The flows now have to be attracted by growth assets such as equities. The rise in commodity prices has enhanced SA’s terms of trade and the outlook for resource companies. The JSE’s resource index has rallied, driven by strong earnings momentum. The rest of the equity basket has also been quite strong, with SAspecific equity counters rerating from very cheap levels to reflect enhanced growth expectations.
This performance in equity prices has not been reflected in strong flows into the equity market, which would offset bond outflows in a growthpositive rotation. The domestic growth outlook needs to improve markedly to anchor this rotation, and for that we need a faster vaccine rollout. This problem illustrates the limits of fiscal and monetary policy in anchoring financial conditions.
Finance minister Tito Mboweni pulled the fiscal policy lever to support lower costs of borrowing, and the Reserve Bank team, led by Lesetja Kganyago, pressed the accelerator to anchor the growth outlook, but the market will probably be looking beyond the Treasury and the Bank when calculating borrowing costs in the immediate future.
The focus has shifted to what is happening to the near-term growth outlook generally and the vaccine rollout plan specifically. The focus is now on health minister Zweli Mkhize.