US interest rates: the good, the bad and the ugly

AS WAS WIDELY expected, the US Federal Reserve (Fed) abstained from increasing its bank rate last Wednesday.

The Fed announced that it would, for now, pause the upward trend.

Global equity and bond markets continued their recovery in anticipation of the Fed's decision as most markets moved strongly already from last Tuesday.

As expected, emerging markets currencies also immediately appreciated against the dollar. The rand to dollar exchange rate moved from R18.71 the previous Friday to trade at R18.18 last Friday afternoon.

On the JSE, equity prices started to move positive in anticipation of the Fed's decision as the all share index gained 2.9% since last Monday.

On the capital market the 10-year bond yield decreased further last week from 10.82% to 10.74% last week.

The sentiment towards a pause in US interest rates started last Tuesday after it was announced that the inflation rate in the US declined to 4% in May 2023, down from 4.9% in April.

This is the lowest since March 2021 and slightly below market expectations of 4.1%, driven by a decline in energy prices.

Also of note was the drop in the core inflation rate to 5.3%, the lowest rate since November 2021. The core inflation rate excludes volatile items, namely food and energy. These two rates supported the argument that the Fed should consider pausing its current cycle of monetary tightening.

The Fed, however, warned financial markets that it only saw this pause as temporarily and held its key rate steady last Wednesday. It said at least two more increases were likely this year in a bid to bring the inflation rate down to its target of 2%. This warning came as a surprise to the market as most analysts did not expect such a hawkish aggressive stance by the Fed.

The Fed also announced that there would be no chance of a cut this year.

It now expects that economic growth for the US to be higher on 1%, against its previous forecast in March of only 0.4%. This gives some room for the Fed to manoeuvre.

Officials also were more optimistic about unemployment this year, now seeing a 4.1% rate by year's end compared with 4.5% in March's prediction.

On the local front, the announcement by Statistics SA that retail sales had shrunk further in April by 1.6% over the last year – slightly lower than the revised 1.5% drop recorded in March. The market had expected a decrease of 1.4%. This figure points towards a strong possibility that the South African economy is likely to grow negatively during the second quarter. Many analysts still believe that the economy will move into a recession by the end of the third quarter.

This week, the release of South Africa's inflation rate for May will draw much attention. It is expected that the CPI increased by 6.2% against the 6.8% year-on-year rise in April. If the rate is now near 6%, the upper target range of the Reserve Bank, then the possibility of yet another increase in the repo rate next month becomes slim, especially after the decision of the US Fed to pause with its rate increase cycle.

On the global economic calendar, the main attraction this week will be the testimony of the Fed chairman Jerome Powell in front of the US senate on Thursday. Analysts and investors hope to find more clarity on the hawkish stance of the Fed to continue to increase rates further this year.

The US will also release housing data this week, indicating the effect of the higher interest rate on the property market.

The UK will announce its inflation rate for May on Wednesday and the Bank of England will make its interest rate decision public on Thursday.