The holidays turned out to be not-so-happy for financial markets, but there is disagreement on who the Grinch was. Many would argue that the Fed was to blame as rate hikes and the automatic reduction in the balance sheet drained too much liquidity too quickly for the equity market to sustain valuations. Others would say that China should have done much more to reflate, open its economy, and play by global trade rules. Algo-trading in thin liquidity was another suspect. And then there was President Trump forcing a partial US government shutdown because the Democrats would not fund the border wall (now steel structure) alongside threats to fire the previously-beloved Fed Chair Powell.
So the 90-day trade truce between the US and China was quickly overwhelmed by the malign confluence of US politics, fears of a hard Brexit, OPEC losing control of the oil price, and disappointing headline PMI data. At least markets are no longer climbing the wall of worry as valuations reflect the anticipated global growth slowdown of 2019 amid elevated policy and political uncertainty. However, this does not negate further downside risk to asset prices, as a slowdown is not the same as a recession. The outperformance of cash and US treasuries in 2018, as well as the flattening in the US yields curve were clear signals that the global economy would face a tougher year ahead. But the market usually pre-empts the economy – this provides the upside risk to returns as valuations have adjusted and stimulus will benefit asset prices before the impact can be gauged in the real economy.
US labour data remains very strong with job gains well-above trend, accelerating wage growth, and previously discouraged workers being enticed back into the market. More upbeat data has been supplemented by Fed Chair Powell signalling patience, as well as ongoing, albeit moderate, net policy easing in China. The FOMC’s dot plot has edged lower and any further rate hikes are no longer on a pre-set path. A more nimble Fed has resulted in the market predicting rate cuts from 2020.Yet the Fed could surprise either way. Data dependence implies less certainty and more volatility.
The outlook for the South African economy remains unsure. The global trade slowdown will weigh on exports, while monetary and fiscal policy tightening will dampen domestic demand. Confidence remains elusive amid elevated political flux. Expropriation without compensation is still untested and may be preventing local and foreign fixed investment. The fiscus and SOEs are fragile with potential adverse sovereign rating consequences down the line. The National Minimum Wage was implemented on 1 January, but the hourly rate was dropped from R20 to R18 with broader exemptions are allowed. The outcry has left Parliament scrambling to introduce corrective legislation to keep the spirit of the minimum wage law alive. Given the intensifying focus on campaigning and need to prevent job losses in an election year, it is not surprising that the pace of reform has slowed. Analysts are hoping that 2H19 will bring a reform- and confidence-induced acceleration in growth, but we have learnt from last year’s exuberance that even if it seems rational, it might be premature. Hence markets will reflect caution on the outlook until uncertainty dissipates.
This leaves the SARB as a price taker on global policy. Structurally, the MPC would prefer a higher real rate, but from a cyclical perspective the global monetary policy pause has given the Bank breathing room. In addition, the GDP acceleration is still too modest and not yet self-sustaining to justify policy tightening on the grounds of the output gap. With the Fed signalling a pause, the rand well-behaved, and the oil price still low, the MPC will most likely stay pat for the time being. Yet the bias on the MPC still has a hawkish tilt, even with the pending departure of Deputy Governor Groepe at the end of January. If the Fed resumes tightening later in the year, then there will be renewed pressure on the SARB to hike.
With bad news already in the price we should not forget the benefit of base effects – 2018 was a surprisingly weak year for SA on numerous counts and some of these will reverse in 2019, hence one should not be overly bearish. To be sure, 5 February will mark the start of the year of the Pig, which is a symbol of wealth in Chinese culture.