The New Year got off to a racing start, thanks in large part to the Powell Put as the Federal Reserve significantly softened its language. The market’s interpretation of the January FOMC statement and press briefing was unambiguously dovish, as the Fed’s patience opens the door for rate cuts and renewed QE. The pause has reduced the risk of a policy error, while the rebound in equity markets has reversed the tightening in financial conditions experienced during 4Q18. Over the past 12 months the market reaction has evolved from good news bad news to bad news is good news.
Yet risks remain elevated: the trade truce has not yet delivered a deal, with auto tariffs again being mooted; the government shutdown in the US dented sentiment; fears abound of a debt crisis or hard landing in China; and growth in major economies continues to be revised downwards. Lower US yields and the fall in the oil price should ease liquidity conditions for saving-short economies, but the dollar remains reasonably firm notwithstanding the market pricing in Fed easing in 2020.
Even so, the strong dollar has not prevented emerging markets from making up some lost ground. Asset prices had arguably overshot to the downside in 2H18, pricing in the growth weakness that has come through in the hard data. And while 1Q19 is expected to be even weaker on the macro front, markets are looking through at potential support from global policy makers.
The domestic uncertainties have been more than offset by the global tailwinds, even if they may turn out to be temporary. Investors’ focus has been Eskom and what the systemically important SOE means for the government’s financial position (the 20 February Budget) and Moody’s rating review (29 March). President Ramaphosa’s 7 February State of the Nation Address (SONA) has committed to splitting Eskom in three and to support the utility in a way that does not adversely impact the government’s credit metrics. While a debt transfer is still mooted, the base case is building for government to step in on interest payments on behalf of Eskom under the guarantee programme. We think the fiscal position can absorb this in the short-term, but note that it is not a long-term option given that SA has moved past the peak in the Laffer curve.
The silver lining is the more benign inflation outlook in South Africa following serial downside surprises in 2018, the lower oil price, and the well-behaved rand. There is still much debate about the strength of FX pass-through and whether margin squeeze will give way to higher inflation. As a result, there are wide-ranging analyst views on whether the next move by the SARB will be a hike or cut – the flattening in the FRA curve is siding with a more dovish interpretation as the MPC follows the Fed. We are not convinced that a rate cuts is a done deal. There is still a structural need for the SARB to run higher real policy rates to counter the lack of fiscal consolidation. Moreover, if the Fed resumes tightening, then there will more likely be an adverse impact on the currency and capital flows.
For now uncertainty is adequately elevated to keep the SARB on the side-lines, until after the 8 May elections.