On Wednesday evening SA time the US’s federal open market committee (FOMC) was due to announce its latest interest rate decision followed by Federal Reserve chair Jerome Powell’s usual post-FOMC press conference.
There was little doubt that the committee would again hold the policy rate at 5.25%-5.5%. The only question was just how hawkish Powell’s words would be. And for SA and other emerging markets the question is how far the Fed’s stance will affect our own currencies and borrowing costs.
The global interest rate outlook has clearly shifted to a “high for longer” scenario in recent months as inflation has proved much stickier in the US than most had hoped. The US inflation rate has now risen for three straight months. In mid-April Powell warned monetary policy would have to stay in restrictive territory for longer.
At the start of this year the market was pricing in six interest rate cuts this year, of 25 basis points each. Now, it’s pricing in just one cut — which may only come after the US election at the Fed’s November 5-6 meeting. And now there are even fears that the Fed’s next move could even be a hike not a cut, in an economy and a labour market that have remained robust.
Over in Europe and the UK, the inflation drivers tend to be a bit different. But there too, the post-pandemic shift from goods back to services has seen goods prices come down, helped by lower food and fuel costs, while the focus shifts to core services inflation, which is traditionally harder to quell.
The bottom line is while inflation has declined significantly over the past two years, as the Reserve Bank’s latest monetary policy review points out, “the return of inflation to central bank targets is ... not assured, as the pace of disinflation has slowed markedly”. And risks still lurk, with geopolitical tensions and geoeconomic fragmentation and all those conflictual trends in the world risking new supply chain disruptions and cost blowouts.
The economies of Europe and the UK have done worse than that of the US and inflation has done better, possibly opening the space for the European Central Bank and Bank of England to start cutting rates before the Fed. But they too may be constrained by the fallout from the Fed, which is the central bank whose decisions loom over us all.
The prospect that the Fed will push out rate cuts will keep the dollar strong. It will keep US assets, particularly US treasury bonds, attractive so that investors don’t have to take the risk of putting their money in riskier assets. That has implications for currency, bond and equity markets globally.
It has particular implications for emerging markets such as SA, which, as the Reserve Bank has frequently pointed out, is in need of foreign capital and can’t afford to do anything to deter it. In Latin America, where many central banks started hiking interest rates even earlier than SA, some have now started cutting. But SA is likely to have less space to do so. And the rand’s recent performance has been volatile, with the currency recently going over R19/$.
Interestingly, the monetary policy review points out how diverse inflation performances have been across emerging markets. Common global food and energy price shocks in 2022 and 2023, as well as global supply bottlenecks, sent inflation to multi-decade highs in all emerging markets except China.
But domestic factors played a role in how severely these transmitted into inflation in each country. And those who saw the strongest increases also saw the fastest declines in inflation rates. Central banks that ran very loose monetary policy saw inflation rise sharply, says the review — but where adequate corrective action was taken, in the form of a swift shift to above-average real interest rates, inflation responded fairly quickly.
There were also marked regional differences. Asian economies experienced relatively shallow inflation peaks and more stable currencies, while the Latin Americans saw early and sharp peaks.
SA has done quite well, says the review. Our inflation peak of 7.8% in July 2022 was one of the emerging world’s lowest. The Bank’s own response takes some credit, along with “well-anchored’ inflation expectations and the fact that SA food prices were less affected by global shocks than many other countries. But here too, inflation has proved sticky in the 5%-6% range. And with the external environment as uncertain and risky as the domestic one, no surprises for guessing the Bank will be its usual cautious self for now.
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