Overcoming the Trump shocks and drawing its implications for SA and Reserve Bank action
The Trump shock has been working its way through the markets. Expectations for US growth under Trump were revised upwards, which benefited US equities generally. Emerging market (EM) equities by contrast have suffered both absolutely and relatively, with the JSE in US dollars performing as it usually does, in line with the average emerging market, with both losing about 6% of their pre-Trump US dollar values.
The market and central bank governors have long feared the impact of higher bond yields in the US on EM currencies, inflation and interest rates. Long term RSA bond yields rose immediately, in sympathy with higher US bond yields. But recent interest rate trends in the RSA bond market have proved much more encouraging. Yields have receded as the spread between RSA and US Treasury bond yields have narrowed, leaving rates little changed from their pre-Trump levels. These are helpful trends and indicate that a feared “Trump tantrum” in the RSA bond markets has not materialised.
A related and similarly favourable reaction can be observed in the currency market. The rand weakened against the US dollar, along with other EM currencies, with the Trump election. But more recently the rand has regained its pre-Trump US dollar value and has performed better than the average EM currency since. More important is that the trade weighted rand has gained significant strength as we also show below. The trade weighted rand is now as much as 24% stronger than it was in mid-January 2016. This strength translates directly into lower import and export prices and so less inflation and less inflation expected.
Not all the recent economic news has been encouraging. The latest GDP release for the third quarter indicates that SA growth trends have deteriorated. Spending by households and the government is barely increasing while capital expenditure by private businesses and public corporations declined significantly. The GDP growth rate of a mere 0.2% in the third quarter can be attributed to an extraordinary growth in investment in Inventories in the third quarter that was enough to offset a very poor reading on net exports. A better net export performance in the fourth quarter and beyond may help compensate for a likely decline in inventories.
The economy will have to grow at a minimal 2-3% rate to cause the rating agencies to sustain our credit rating. It will take meaningful growth enhancing structural reforms to raise growth rates permanently to higher levels. These appear unfortunately unlikely and would take time to achieve results.
A cyclical recovery is however distinctly possible and could take GDP growth up to a 2-3% pace. Such a cyclical recovery would have to be led, as it always has to be led, by a significant pick-up in household spending propensities. Households have to spend more to encourage firms to invest more in equipment and people to meet their extra demands. Lower short term interest rates are essential to the all-important purpose of a cyclical recovery.
Inflation in SA is now very likely to recede below the upper band of the inflation targets. There is always a risk that these recently favourable trends may reverse. But there is a much greater probability that the economy will continue to stagnate dangerously, leading to political and economic stability for want of a stimulus to spending. Inflation is no self-fulfilling process in SA. The relevance of so-called second round dangers to inflation that may accompany inflation expectations is a theory for which there is no good evidence. Inflation expected is much more likely to follow than lead inflation as the evidence does reveal.
The Reserve Bank focus, narrative and action should respond accordingly by addressing the downside risks to the economy and lowering interest rates. And by recognising an improved outlook for inflation, rather than to focus further on inflation risks, over which they have no predictable influence. 8 December 2016