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The importance of the US economy for the SA economy and its financial markets was again demonstrated last week. Some good news about the state of the US economy came in the form of the Institute of Supply Managers’ (ISM) latest report on manufacturing activity. This indicated good underlying growth, sending US long term interest rates higher on Friday.
SA yields moved in the same upward direction. More importantly, the gap between SA and US yields widened on Friday 1 November (as we show in the chart below), indicating that more rand weakness is expected over the next 10 years than was expected the day before.
US 10 year bond yields rose from 2.48% to 2.62% on Friday. These long term rates had earlier approached 3% after news of possible Fed tapering entered the markets in late May 2013. By tapering we mean reducing the monthly Fed injections of cash into the banking system, now running at US$85bn a month.
The manufacturing sector indicator was better news for the US economy than for emerging market (EM) economies. The US economy may be in a position to withstand higher interest rates when the Fed eventually begins tapering its injection of additional cash into the system. But higher interest rates are not called for in most emerging market economies, including the SA economy (at least not for now).
In the figure below we show how the S&P 500 Index outperforms the JSE (and the MSCI EM Index, the emerging market benchmark) when the gap between US and SA (and other EMs) interest rates widens and vice versa when the yield differences narrow.
In due course any sustained strength in the US economy will percolate through to the rest of the world and its stock and currency markets. But until such dispersed economic strength is apparent, investors in emerging markets must hope for a slow, steady recovery in the US and for not significantly higher US long term rates. The chart below shows that the recent weakness in the rand was shared by other emerging market currencies.
Thus it seems clear that for now, the more the Fed delays tapering, the better for EM economies and their stock and currency markets.
