12/04/19

Interest Rates

In collaboration with Nedbank

The U.S. Federal Reserve’s Federal Open Market Committee (FOMC) is set to meet again at the end of April, announcing its overnight interest rate (the fed funds rate) decision and updating its policy outlook. In March this year, the FOMC surprised markets by announcing a significant shift in its policy direction by indicating an abrupt halt to the gradual normalization of interest rates.  

The fed rate was unchanged from the end of 2008 until December 2015, the longest time frame of an unchanged rate in the Fed’s history (prior to this, the longest period was from August 1992 to Feb 1994). Subsequent to this, rates were hiked once each in 2016 and 2017, three times in 2017 and four times in 2018 – the latest being in December. The hikes in 2018 are the most in a calendar year since 2006, when rates were hiked in an attempt to cool the housing market bubble. The rate hikes over the past few years have been an attempt to return to a more normal footing during a period of stable economic growth, low unemployment and mild inflation.

The about-turn from a hawkish to a more dovish stance occurred in the space of six weeks. The core reasons for this are slowing global growth (particularly in China); the impact of the trade war between the US and China; and downgraded growth, unemployment and inflation forecasts for the US; amongst others. Just a few months ago the FOMC signaled three further hikes were in the pipeline before pausing rate normalisation, at least one hike during the course of 2019. Given the global environment and increasing anticipation of sluggish US economy, the FOMC has since indicated a pause in rate hikes for the foreseeable future and will suspend the unwinding of its balance sheet at some point during the year.

This volte-face in the U.S. has an impact closer to home. With a pause in global interest rate normalisation, the South African Reserve Bank will not see their hand forced (on this front, at least). The usual factors, such as the domestic growth outlook and inflation, will play a key role as always. As it stands, South Africa’s inflation rate is well within the SARB’s target range and the economic outlook sees some, albeit weak, growth. This suggests that the SARB will not be in a rush to increase the repo rate any time soon and will likely hope to maintain the status quo or cut rates should there be room for such a move (such as low inflation and a deteriorating growth outlook amidst the global normalisation pause).

Should South Africa hold the rate as is, we can expect the Bank of Namibia (BoN) to follow suit. The weak economic growth forecast for Namibia, off the back of two years of recession, coupled with low credit extension will see Namibia’s central bank hesitant to hike rates. However, this decision does not entirely lie in their hands. Our central bank’s mandate is to maintain the currency peg with the South African rand, and as any economist worth their salt will tell you, no central bank can simultaneously maintain a fixed exchange rate regime, free capital movement, and independent monetary policy (known as the ‘impossible trinity’). With the 25bps SARB hike in November 2018, there is no longer a buffer between Namibia and South Africa, and so should the SARB choose to hike in future, BoN will be forced to do the same.

The pause in global interest rate normalization thus comes as some relief, providing some more discretion for the South African central bank, and by extension some breathing room for the BoN. Local market expectations have followed the global trend, with the latest forward rate agreement (FRA) curve showing that no rate change is expected during the course of this year or next year. However, it is important to remember that these sentiments can change quickly, especially when changes are signaled by the FOMC.