Macro Pulse Episode 30

Hello and welcome to Macro Pulse. The conflict in the Middle East continues to dominate market movements and on Wednesday, after 6 weeks of fighting, the US and Iran agreed on two weeks of ceasefire. Israel also agreed to this ceasefire, but it said it excluded its operations in Lebanon. And Iran has promised to open the Strait of Hormuz, although we haven’t seen a pickup in traffic through the strait yet and unlikely to see that in the short term.

Over the next two weeks, both parties will come together and they will discuss issues like the control of the Strait of Hormuz, the lifting of Iran sanctions, Iran’s nuclear program, US military presence, as well as war reparations. The two sides is expected to start meeting this weekend in Pakistan. Importantly, both sides claimed victory, which is important for to see further deescalation. However, this conflict is not over and there are several issues that could reignite this conflict. However, these signs are very positive and we believe that could ultimately lead to further deescalation.

Markets celebrate this ceasefire news as the S&P 500 on the day on Thursday jumped 2%. Global bond yields fell and the US dollar also weakened. But it was emerging markets that benefited the most because the oil price fell from about $110 to the low 90s. And emerging markets has been the most exposed during this conflict to a higher oil price, a stronger US dollar, and also, um, higher bond yields. Just looking at South African assets, the equity market went up about 4%, the currency strengthened about 2%—the most within its EMs—and bond yields fell 50 basis points.

So these market movements suggest that outside of the Middle East conflict, the fundamentals for emerging markets remains fairly robust still. So if the conflict in the Middle East could last a few more weeks rather than months, we could see that emerging markets start to do better with the US dollar reasserting its downtrend, commodity prices doing better, and also central banks again considering to cut rates rather than hike interest rates, even if the oil price remains in this $80 to $90 range. But the recovery amongst emerging markets will be uneven; for instance, China and Latin American countries are less exposed to a high oil price.

But let’s think about South Africa. South Africa is a net importer of energy, and its energy import bill is around 5% of GDP. That is less than that of India but higher than that of Brazil. And while South Africa imports most of its energy demand, 25% of the liquid fuel demand is supplied by Sasol through its coal-to-fuel technology. Now, this acts as a important buffer to fuel shortages. So our economy is actually more driven by coal, as South Africa remains one of the most intensive users of coal globally and coal makes out about 2/3 of our total primary energy.

But like many emerging markets, fuel makes out a large portion of the consumer basket, and around 4% of South Africans’ consumer basket is directly exposed to fuel prices. If you include the indirect exposure—so via food, goods, and energy—that rises to about 12 to 15% of the consumer basket that is exposed directly and indirectly to the higher fuel price. So the economy is fairly dependent on fuel, and specifically on diesel, as it relates to activities in the agricultural sector, also transport and electricity generation.

So earlier this month, the government, um, has pushed up the price of both petrol by about three rands and diesel by about 7 1/2 rand; that is even after they’ve announced a cut in the fuel levy of about three rands per liter. In the short term, this fiscal cost can be absorbed. Um, we saw in the latest budget numbers by National Treasury that the revenue overrun for this year relative to the budget in February is going to be 3 billion, and there’s also a 5 billion contingency reserve in the 26/27 budget that can be used to pay for some of this buffer.

But you can see that this fiscal buffer can only last for so long—perhaps two to three months at most—before it really starts to, um, impact the fiscal cost. What other countries have done around the world is that they have told people to start to work from home. They have also increased subsidies. In many cases, they’ve even asked shops to close earlier, um, and for less movement. We haven’t seen that in South Africa yet, but that is what has happened amongst many emerging markets to ensure that people use less fuel and less energy.

So in the short term, if you think about the impact on inflation by the higher fuel price, um, in the April number—because of this cut that we saw in the fuel levy—inflation could still come in at below 4% for the April print, and for the year, it could still also come in below 4% on average, um, if we indeed see that the ceasefire holds and we start to see a normalization of flows through the Hormuz. That means that the SA may actually hold off from hiking interest rate as he sees this as a short-term supply, um, disruption or supply shock.

In fact, what we will likely see is that even if the oil price comes back to between $80 and $90, we will likely still see hit to disposable income levels, we will see a hit to investment, investment confidence, and also business cost would have risen relative to what it was last year. So all of that means a slowdown in economic growth; instead of us growing at say 1 and a half to 2%, we’re likely to grow maybe again around 1%. That means that looking forward—so looking at the end of the year or perhaps in the in the first half of next year—not only will the higher oil price now start to fall out of the base on a year-over-year CPI impact, but also we’ll most likely still see slower growth, which means that ultimately in a year’s time, the SA may be in a position and be forced to have to cut interest rates to support the economy.

If you think about South Africa, it is that our cyclical recovery has not been derailed; it has been delayed rather. And if you look through the cyclical growth story that is likely to weaken in the short term, the structural growth story remains in place. We continue to see that the GNU is holding; in fact, there’s a, um, coalition bill currently being on the table, and if that is being signed off later this year, it could further strengthen, um, the stability within the coalition.

We also see that the municipal reforms will likely lead to better service delivery. Infrastructure spend is picking up and that is locking in the private sector. Ongoing network reforms around ports and rail, water, electricity—that is ongoing—and fiscal consolidation remains a focus, which means that the funding cost of the country would potentially be also lower than it was, um, in the past. All of that then, combined with the fact that valuation still remains attractive and therefore you see foreign investors continue to ask and look around, and specifically focusing on some South African assets within the emerging market space to look for opportunities. That is all for this week. Thank you for watching.

Turning to South Africa. We had the SARB meeting and despite the fact that the rand has appreciated that they have reduced the inflation forecast for this year, that the fuel prices are falling and that weak growth continues, the SARB decided to keep rates on hold. We believe there’s still scope for the SARB to cut rates to 6% and potentially below 6%, but this will be a gradual process. One in which the SARB will remain cautious.

We also received news that President Trump and Congress have signed an extension to the AGOA agreement, an agreement between the US and African nations, to extend that program for another year. While this is good news, the tariff rate onset effect remains 30% and just this week, the US and India signed a deal in which the Indian tariff rate was reduced from 50% to 18%. This is a sign that for South Africa, there is still some scope to negotiate a lower tariff rate with the US. Thank you for watching. That’s all for this week.