Macro Pulse

Hello and welcome to Macro Pulse. This week we cover four big themes: Jackson Hole and the shift in Fed policy, the relentless rise in long bond yields, the latest on the Middle East and oil, and developments here in South Africa heading into the local government elections.

But let’s start with Jackson Hole and the Fed. Last week at Jackson Hole it was Kevin Warsh’s first speech, and it landed more hawkish than the market expected. Hawkish meaning the probability of hiking interest rates has increased. The market is now pricing that probability to be almost 70%, where before the meeting it was only 40%. His language on the economy was upbeat: strong capex, rising profits, easy credit. But on inflation he noted that the level is too high, and while the direction of inflation is down, the speed is too slow. So with 54% of the CPI items now rising above 3%, if you compare that with only 32% of items rising above 3% in the period before COVID, it still seems elevated, and that is what is concerning the Fed. He reaffirmed that 2% PCE inflation remains the firm and fixed target. And if we compare that with the latest PCE, which was 3.7%, again we see that this level is uncomfortably high. So while the housing-related components of inflation have fallen back to pre-COVID norms, the goods and services ex-housing components remain quite high because of ongoing supply chain disruptions, high energy costs and tariffs. Markets are becoming increasingly uncomfortable with this higher inflation, and we can see that also playing out in bond yields, specifically at the long end of the yield curve.

Warsh tried to calm bond markets and show his independence. He also used the Jackson Hole platform to signal potential reforms at the US Federal Reserve, and he explained why he believes the Fed should provide less forward guidance. His argument is that the Fed signals its next move by providing forward guidance, and if it does that, markets simply price in that guidance rather than the real economy, leaving the Fed with no genuine read on what is coming from the market and market conditions. He’s calling it the hall of mirrors problem, and he believes this will allow for more policy-setting flexibility. Apart from the Fed, the ECB and the Bank of Japan are also expected to hike interest rates at the upcoming September meetings.

On to long bond yields, which remains the dominant theme in the market at the moment. The rise in the 50-year yield isn’t just a US story. Yields in the UK, Japan and Germany are all rising, reflecting higher inflation dynamics, positive growth, but also concerns around the fiscal side of these economies. In the US, the fiscal picture continues to deteriorate. We see that the national debt now stands at about $40 trillion US, which means that the annual interest cost is now rising to about $1.3 trillion, and the CBO projects that interest costs alone will reach about 20% of government revenues over the next 10 years, which is similar to South Africa. So bond yields continue to rise despite efforts from both Treasury Secretary Scott Bessent and Kevin Warsh to keep the lid on it, and these rising bond yields should weigh on sentiment because it implies higher mortgage costs, higher government funding and also tighter financial conditions in general. The market may experience some volatility as authorities try to grapple with and contain these higher bond yields.

Turning to the Middle East and oil, the US-Iran memorandum of understanding is effectively dead, and there has been a renewed exchange of fire between Iran and the US in the last few days. This has pushed the price of oil well above $90. Now, Washington’s broader approach remains that of maximum economic pressure on Iran, now through secondary sanctions on Iran’s trading partners. China alone accounts for about 30 to 40% of Iran’s trade. South Africa’s own exposure is very minimal, though; we only rank as Iran’s 29th largest trading partner. The price of oil fluctuates around Middle East headlines, but fuel prices are increasingly influenced by product refining margins, the cost to convert crude oil into petrol, diesel and jet fuel. These reduced refining capacities across the Middle East and Asia are pushing up the price of fuel, which is adding to inflationary pressures.

In South Africa we can see that for September the price of petrol will rise by about R1.30 and the price of diesel by R3.20. So while headline and core inflation in South Africa have dropped recently, it still remains well above the upper band of the target range. With oil refining margins high, global food prices rising and the El Nino weather patterns strengthening, the risk of local inflation remains on the higher side. It could mean that inflation remains high for a little bit longer, which also increases the probability that the SARB may hike rates later this month.

Finally, a word on the potential outcome of the local government elections. The Western Cape is the only province where the unemployment rate has fallen between December 2019 and today. It’s also the province with the highest percentage of clean audits amongst municipalities. But the Western Cape only makes up 15% of the country’s GDP, and the city of Cape Town around 10% of the country’s GDP. In contrast, Tshwane, Johannesburg and Ekurhuleni make up about 30% of the country’s GDP. Now, if the local government election outcomes for these metros can develop into strong coalitions which are aligned with the GNU, and they manage to implement reforms and achieve cleaner audits, they can have a significant impact on the country’s overall growth trajectory.

So in summary, while the AI economy in the world is going strong and economic data in the US remains robust, we see the potential for some volatility into the US midterm elections early in November. We see recent escalations in the Middle East and Russia-Ukraine conflicts. The US and China will meet later this month. There are multiple core central bank meetings this month as well, which may result in higher interest rates, and long bond yields continue to rise. All of this could still weigh on market sentiment. That is all for this week. Thank you for watching.