As the world enters 2022, it appears increasingly likely that this will be a year of progressively rising interest rates, not just in the US but around the world.
At long last, US Federal Reserve chair Jerome Powell has come to terms with the realisation that inflation in the US is not necessarily “transitory”, and at the last Fed meeting it was stated unequivocally that interest rates would rise in 2022 and 2023 in response to higher inflation.
Powell’s predecessor, current US treasury secretary Janet Yellen, stated back in May 2021 that interest rates would probably have to begin rising in the US to cool the economy. For this remarkably honest observation, she got slapped down and had to make an embarrassing retraction. She’s now having the last laugh. But higher global interest rates will have consequences, regardless of how much of the rises have already been factored into markets.
November’s US inflation rate was 6.8%, the highest in 40 years (and significantly higher than SA’s current 5.5%). The main drivers of this were gas, food and housing, with petrol being especially high, rising by 58.1% in November, the largest 12-month increase since 1980. And while inflation may well have peaked at these very rarefied levels, the downwards trajectory from here on could be stubbornly slow.
The UK is following a similar trend, though not quite as acute, with November’s inflation rate coming in at 5.1%, the highest in a decade. In the eurozone, inflation hit 4.9% in November, the highest for the 19-member bloc since the establishment of the euro.
So there can be little doubt that in the world’s biggest economies, inflation is relatively high and is unlikely to fall significantly any time soon, so interest rate rises are inevitable. As this happens in developed markets, rises in emerging economies are likely to follow.
But to what extent are these already factored into markets and what will be the likely effect on equity and currency markets? Within the US, highly rated high-growth technology stocks will become increasingly vulnerable to gradually rising rates, as their projected cash flows start to recede.
Already this year, many speculators have discounted a gradually rising US interest rate environment, and this has resulted in a strong dollar. But as 2022 progresses, and the omicron-induced “fourth wave” quickly subsides and the world starts normalising more rapidly, the potential for the dollar to continue appreciating may be limited. But in the short term, emerging-economy currencies may continue to weaken in response to the stronger dollar.
And those emerging economies with high debt-to-GDP levels, such as SA, may struggle more than most in such an environment. Higher interest rates in emerging economies will result in higher interest charges on the increased debt taken on to combat the pandemic.
The SA 10-year bond yield closed at 9.35% on Friday December 31 2021, compared with 8.6% a year earlier. These bond yields still remain attractive to foreigners both in nominal and real terms, however. Only Indonesia has a higher real bond yield (10-year bond yield minus inflation) of 4.6%, compared with SA’s 3.85%. SA’s inflation rate appears to be well-anchored and caused mainly by imported inflation, as demand-pull inflation is virtually non-existent in the languishing SA economy.
This situation poses a real dilemma for the SA Reserve Bank and its monetary policy committee (MPC). Though it will be tempted to keep interest rates rising to combat rising prices, in so doing it runs the risk of interrupting the fragile economic recovery that has been in place since the third quarter of 2020. But if rates don’t rise, then foreigners will increasingly look elsewhere for high real interest rates.
Speaking after the last meeting of the MPC in November 2021, Bank governor Lesetja Kganyago said the implied policy rate path of the quarterly projection model suggests further rate increases in each quarter of 2022, 2023 and 2024.
• Gilmour is an independent investment analyst with Salmour Research.
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