The interest rate outlook for South Africa and what it means for the Nedgroup Investments Cash Solutions funds
The year 2020 was laden with great economic risks which were further worsened by the breakout of the novel COVID-19 virus. A growing trend in supply-side constraints emanating from electricity shortages, increasing global trade tensions, and rising levels of policy uncertainty, rendered the local and global economic backdrop particularly uninspiring.
The magnitude of this economic recession once again muted demand for crude oil, where low demand levels and high storage costs saw the price of this commodity slip into negative territory amid high inventory levels.
Solace for global investors was subsequently found in cash type assets and gold bullion, where excess liquidity and production limitations resulted in cascading yields and an increase in the commodity spot price, respectively.
High yielding and commodity-linked emerging market currencies such as the rand, then appreciated significantly against the United States dollar and other G7 currencies.
This resiliency of the rand on the back of weak global oil prices not only contained inflation, but further enabled monetary policy authorities to cut short-term interest rates by 300 basis-points.
Looking ahead, the overarching expectation is for short-term interest rates to recover from current levels. The expected magnitude of rate increases varies depending on the reference source (see below).
Repo Rate Outlook
Key drivers of this interest rate outlook are underpinned by a recovery in the global inflation cycle as well as a narrowing output gap.
Expansionary global fiscal policy and the lifting of lockdown restrictions are set to be growth positive, especially coming from a low production base. A successful implementation of the COVID-19 vaccine rollout program as well as a strong efficacy of the inoculation thereof, can further improve economic activity through anchoring policy and business confidence. In the short-term, we envisage this resumption in economic activity to outpace spare capacity as the global demand for final products looks to outweigh the supply of capital goods.
For this reason, global oil prices have increased by 37% in rand terms in the first quarter of the year, while electricity costs have been confirmed to rise by approximately 16% from the second half of the year. A build up in global savings from a rise in cash investments is also likely to decrease, the more certain policy and political expectations become. This decrease in savings should benefit production assets, improve capital expenditure programs, and increase the labour participation rate.
The short-run phenomenon of a low-base effect inspired growth trajectory and slow improvements in the labour market have made our short-term interest rate outlook less aggressive relative than that of the Forward Rate Agreement (FRA) market.
The FRAs are also pricing in more aggressive interest rate hikes than the surveyed median expectation envisages. This reflection of the market’s view seems to be possibly overstated by the near-term positive output gap, where economic activity is set to outpace its spare capacity and potential growth rate as a function of low base-effects following a deep and long-standing economic recession. In the absence of formidable structural reform, limited government spending capacity, and constrained labour market conditions, a positive output gap appears to be short-lived, thereby limiting the scope of aggressive policy rate hikes.
Furthermore, tepid consumer demand levels and the recently introduced increases in indirect taxes are set to reduce the pace of CPI recovery. We are however mindful of the sharp incline in fuel and electricity costs which appear to be understated in the surveyed median forecasts. To this end, our outlook is slightly more hawkish than that of the Bloomberg peer median, as pass-through and administered price inflation are poised to bear adverse effects on transport and food price inflation.
The investment philosophy of conservative credit selection and low duration continues to support returns in our cash funds. The Nedgroup Investments Cash Solutions funds have a bias towards floating rate instruments linked to 3-month Jibar. This bodes well for future yields of the funds given the general interest rate view of anticipated increases. While we look for opportunities, we remain prudent around credit, and we continue to manage the liquidity and maturity risk as efficiently as possible.