US interest rates: the good, the bad and the ugly
As was expected the US Federal Reserve abstained from increasing his bank rate last Wednesday. The Fed announced that it will for now pause the upward trend. Global equity and bond markets continued their recovery in anticipation of the Fed’s decision as most markets moved strongly already from last Tuesday.
As expected, emerging markets currencies also immediately appreciated strongly against the dollar. The rand to dollar exchange rate moved from R18.71 the previous Friday to trade at R18.18 on Friday afternoon.
On the JSE, equity prices started to move positive in anticipation of the Fed’s decision as the all share index gained 2.9% since last Monday. On the capital market the 10-year bond yield decreased further last week from 10.82% to 10.74% last week.
The sentiment towards a pause in US interest rates started on Tuesday after it was announced that the inflation rate in the US declined to 4% in May 2023, down from 4.9% in April. This is the lowest since March 2021 and slightly below market expectations of 4.1%, driven by a decline in energy prices.
Also of note was the decline in the core inflation rate to 5.3%, the lowest rate since November 2021. The core inflation rate excludes volatile items, namely food and energy. These two rates supported the argument that the Federal Reserve should consider pausing its current cycle of monetary tightening.
The Fed, however, warned financial markets that it only sees this pause as temporarily and held its key rate steady Wednesday. It said at least two more increases are likely this year to bring the inflation rate down to its target of 2.0%.
This warning came as a surprise to the market as most analysts did not expect such a hawkish aggressive stance by the Fed. The Fed also announced that there would be no chance of a cut this year. The Fed also now expects that economic growth for the US to be higher on 1.0%, against its previous forecast in March of only 0.4%. This gives some room for the Fed to manoeuvre in. Officials also were more optimistic about unemployment this year, now seeing a 4.1% rate by year’s end compared with 4.5% in March’s prediction.
Locally, the announcement by Statistics South Africa that retail sales had shrunk further in April by -1.6% over the last year - slightly lower than the revised -1.5% number recorded in March. The market had expected a decrease of 1.4%. This figure points towards a strong possibility that the South African economy is likely to grow negatively during the second quarter. Many analysts still believe that the economy will move into a recession by the end of the third quarter.
This coming week, the release of South Africa’s inflation rate for May 2023 will draw much attention. It is expected that the CPI had increased by 6.2% against the 6.8% year-on-year rise in April 2023. If the rate is now near to 6.0%, the upper target range of the Reserve Bank, then the possibility of yet another increase in the repo rate next month becomes slim, especially after the decision of the US Fed to pause with its rate increase cycle.
On the global economic calendar, the main attraction this week will be the testimony of the US Federal Reserve chairman Jerome Powell’s testimony in front of the US senate on Thursday. Analysts and investors hope to find more clarity on the hawkish stance of the Fed to continue to increase rates further this year.
The US will also release various housing data this week, indicating the effect of the higher interest rate on the property market. The UK will announce its inflation rate for May on Wednesday and the Bank of England will announce its interest rate decision on Thursday. The market expects another 0.25% in the repo rate for the UK. On Friday Japan will publish its latest inflation rate number, while the UK will publish its retail sales numbers for May. It is expected that the sales at the shops had decreased by 0.2% on a year ago.
The rand, global and domestic equity markets, and bond rates are expected to recover further during this coming week.
Chris Harmse is the consulting economist of Sequoia Capital Management
BUSINESS REPORT