The tale of interest rate increases

Dr Francois Stofberg
Senior economist and head of sales: Efficient Private Clients

During July, the main themes on the economic front were interest rates and the fight against inflation. Most central banks across the globe have now set their firing power against inflation. Past rumours around ‘transitory’ (read temporary) inflation have long since quietened down. In fact, many analysts are now pushing out their forecasts for when they believe inflation will be back in the different target ranges that the central banks have set.

In South Africa (SA), the South African Reserve Bank (SARB) increased interest rates by 0.75% after Statistics South Africa (Stats SA) reported that annual inflation reached 7.4% in June, slightly outside of the SARB’s target range of 3% to 6%. In total, the SARB has now increased rates by 2% since they started this hiking cycle in November 2021, increasing the repurchase rate to 5.5%, and the prime rate to 9%. Consumers who have been worn out by higher fuel and food prices, as well as low wage increases and job creation opportunities, are in a lot of pain. But even on a global scale, consumer sentiment is approaching all-time lows as consumers are wary about their financial prospects over the medium term. Our view is that local interest rates will probably increase by another 0.50% this year, and then by 1% to 1.5% in 2023.

In the United States (US), the Federal Reserve (Fed) also increased interest rates by 0.75% for the second consecutive month. These recent increases are the most aggressive tightening by the Fed in more than a generation, and have taken the federal funds rate (that is, the repurchase rate) up to 2% to 2.25%. Market observers compare these rapid increases with the price-fighting action taken by Fed Chair Paul Volcker in the early 1980s, shortly after inflation peaked at around 14.5%. US inflation has not soared to these levels again but did recently peak at a new four-decade high of 9.1%. For this reason, US officials expect the federal funds rate to reach 3.4% in 2022, and 3.8% in 2023. They are hoping that these additional increases of 1.15% to 1.55% can bring inflation back to their 2% target in late 2024, without pushing the economy into a hard recession in the next 18 to 24 months. Technically, the US has now entered a recession, after their Department of Commerce reported that the economy shrank in both the first and second quarters of 2022, by -0.9% and -1.6% respectively.

However, the US has not entered a ‘hard’ recession yet. This would be characterised by a broad-based and sustained contraction where unemployment increases rapidly. In fact, unemployment remains at a near record low of 3.6% and shows no signs of weakening. Whilst the overall economy shrank in both the first and second quarters, consumption increased by 1.8% and 1% respectively. Demand also remains high because of a decade’s worth of loose monetary policy and the more recent support from fiscal policy. Mostly, it was inventory volatility that caused the contraction, wiping 2% off the economic growth figure. Inventory management has been very difficult the last two years, partly because of supply-chain problems and partly because of hyped-up demand. Higher interest rates have further throttled residential and business investments, which might continue to weigh down economic performance, but we see no sign of the US entering a hard recession. For now, the news of a technical recession will, most likely, not prevent the Fed from increasing rates until they see demand ease off, and unemployment starts to rise.

The cost of higher interest rates in SA

Dr Francois Stofberg
Senior economist and head of sales: Efficient Private Clients

In total, interest rates have increased by 2% during the current hiking cycle in South Africa (SA). In November 2021, the South African Reserve Bank (SARB) started the hiking cycle by increasing interest rates by 0.25%. Many South Africans hoped that these types of increases would continue, especially after a similar increase was made by the SARB in January 2022. But since then, these hopes have faded. Last week, the SARB decided to increase interest rates by 0.75%, after not too long ago increasing rates by 0.50%.

What does this mean? It means that each R1 million debt that a household has will now cost R20 000 more each year, or R1 667 more each month. This is a substantial increase. Although each household should estimate the impact that interest rate increases will have on their budget, and plan accordingly, the picture does not look any better if we consider the impact of higher interest rates on the economy.

According to the SARB, household debt, expressed as a percentage of disposable income, that is, the income that you take home, is about 65% in SA. Total annual disposable income, at current prices, is somewhere close to R3.85 trillion, which means that total household debt is roughly R2.50 trillion. This means that, in total, South Africans will now pay R50 billion more for their debt each year.

The next step is to estimate what the likely impact will be on each household. To do this, we must try and determine what the average debt per household is. Based on credit data from different sources, it seems that there are about 6 million consumers (read households) with debt. Many of these consumers have multiple debt-related accounts, from bonds on their houses, to credit cards, as well as different types of loans. It should also be noted that the figure can differ substantially depending on the source of information that we use, but 6 million seems to be a good estimation of the total. What this means is that these 6 million consumers owe R2.50 trillion, and the average debt is, therefore, about R415 000. If we use this figure as an accurate estimation, it means that indebted consumers are now paying R8 300 more for their debt each year, or R692 more each month. If we then consider that the average income in SA is between R15 000 and R17 500, depending on the source of information that you use, households will now have between 3.22% and 3.95% less to spend on necessities each month.

The question now is: Is it over? Unfortunately, it does not seem so. Although, from a macro perspective, we agree that interest rates should increase, we do not agree with the pace of the increases. Interest rates are not being increased to curb inflation because the SARB’s increases have very little impact on higher fuel and food prices, the main culprits of inflation. Also, unlike in rich countries, we do not have above-trend demand pushing up prices. In fact, demand has been under severe pressure for many years in SA. Interest rates should increase to remain competitive in international capital markets that can help with short-term capital flow and long-term economic performance, but for this it is not necessary to increase interest rates at the current pace. It seems that the SARB will increase interest rates by at least another 0.50% this year and should increase interest rates by a further 1.50% in 2023.

Crypto regulation and US inflation

Dr Francois Stofberg
Senior economist and head of sales: Efficient Private Clients

In an interesting interview, the Deputy Governor of the South African Reserve Bank (SARB), Kuben Naidoo, provided some more guidance about cryptocurrency regulations in South Africa (SA). We have long since held that more regulation is necessary in the cryptocurrency environment, but more of the right type of regulation. Regulation should protect consumers against scandals like Mirror Trading International (MTI) that scammed thousands of people worldwide out of billions of rands. But regulations should not infringe on people’s freedom, for example, by telling them what they may or may not invest in. Regulations should also not suppress innovation like it does in many countries, especially in Europe’s financial industry. Usually, regulators get it wrong and impose unnecessary regulations that benefit only a handful of companies, or even individuals, at the expense of the majority.

According to Naidoo, cryptocurrency regulations could be implemented in the next 12 to 18 months, and will be aimed at protecting investors, securing cryptocurrency platforms, and identifying criminal activities, among others. If the SARB can move so rapidly and with such efficiency, it will, undoubtedly, be a boon to the industry and will place SA well ahead of the curve. A lack of sufficient regulation globally has, to a large extent, prevented the mass adoption of this superior technology that can address many of the shortcomings in the traditional financial sector, but also in other sectors. Shortcomings like the extraordinary layers of fees associated with financial transactions or even investments. Shortcomings like the delay in receiving money: Why must it take more than two days for me to receive money from someone who sent it to me from another bank? Another shortcoming is only being able to trade financial instruments between 09:00 and 17:00, and only during the workweek. What blockchain technology, like smart contracts, can also do is to bring full transparency to finances: Imagine being able to see where every single rand of every single government tender went! Blockchain technology can make this possible.

If you really think about it, the list of benefits that blockchain technologies can hold for the traditional financial sector, and beyond, seems endless. But regulation has been slow. Mostly because of the nature of the technology: There is no single champion that can innovate, lead, and set the standard like we see in the broader technology sector. When Facebook, Google, Amazon, Uber, and the like disrupted their markets, the motto was often to ‘move fast and break things’. But a similar approach simply will not do in the financial industry where people’s livelihoods depend on it. Also, most of the cryptocurrency world is decentralised, which is a completely foreign concept to the centralised world we live in, and which the masses have come to rely on. But regulation has also been slow because of reluctance to adopt the technology in the traditional financial sector. Blockchain technology has the potential to upend the entire industry – a change of this magnitude scares those who are still living off the rents of the prehistoric era.

In other news, inflation, once again, reached a new 40-year high of 9.1% in the United States (US). This news surprised investors who were expecting a much more moderate reading. Many were expecting the Federal Reserve’s (Fed’s) recent interest rate increases to start reigning in surging prices in the US. Even though higher fuel prices, driven by the war in Ukraine, is the main culprit for the persistent increase in US inflation, many now expect that the Fed will continue to increase interest rates at a rapid pace. As a result, the US dollar reached parity against the Euro, strengthening to a 20-year high against the Eurozone’s currency. For this reason, the rand has also been under tremendous strain, remaining at levels above R17.00 against the dollar.

An update on the rand

Dr Francois Stofberg
Senior economist and head of sales: Efficient Private Clients

Until recently, the rand has remained resilient against the United States (US) dollar. But during the past couple of weeks, the pressure has simply been too much for the rand to bear, causing it to depreciate to levels around R17.00. In the past, the rand’s demise was primarily driven by bad local politics, which led to bad policies, which, ultimately, led to negative sentiment. Everything that led up to, and including, Nenegate was a good example of this. But this time, the rand’s depreciation has more to do with an increasingly strong dollar.

Following its historic pattern, the dollar has been gaining considerable momentum against most other currencies, as the US central bank, the Federal Reserve (Fed), has been increasing interest rates at a much more rapid pace than most other countries have been able to. Not even the South African Reserve Bank’s (SARB’s) in-step increases have been able to do much to prevent the deterioration of the rand. Some analysts even expect the SARB to continue increasing interest rates by another 2% in 2022: I think that is a bit unnecessary and, as we have seen, it will not do a lot for inflation or the rand. Therefore, plan for another 2%, but expect at least another 1%.

Everything, it seems, is favouring the dollar, which has placed the rand between a rock and a hard place. On the one hand, if the US economy does well, the markets will expect the Fed to continue to increase interest rates at a more rapid pace. This happened on Friday when the US Department of Labour reported that the US economy added 372 000 new jobs in June, beating expectations by nearly 100 000, and keeping the unemployment rate at near full employment, namely 3.6%. In these instances, the US economy will continue to offer better returns and, therefore, drain liquidity from the rest of the world.

On the other hand, if markets fear that the Fed, and other developed country central banks, will overshoot and push the global economy into a recession, then investors will reduce their riskier investments in emerging markets and run to safe havens. Because the US offers better risk-adjusted returns, investors end up piling into the US dollar, which, once again, supports the dollar at the cost of emerging market currencies, like the rand. But during recessions countries also demand less of our goods, which puts pressure on our capital account, which ends up weighing the rand down. Excluding the COVID-19 slump, the previous two recessions in 2001 and 2008/2009 knocked as much as 13% off the rand’s value. Some analysts, therefore, expect another 12% downside to the rand if a global recession materialises. We believe that, even if this does occur, and the rand depreciates another 12%, that the rand should then remain strong for at least some years after the recession, as markets recover and the transition towards emerging markets solidifies.

What this means for investors is that, during the next 6 to 12 months, the rand, like most other currencies, will face an uphill battle against the US dollar, and during this time ZAR/USD movements will remain volatile. We can easily expect swings around 5% a week. We might even see moves like these happen on specific days. As long-term investors, and considering the data that we now have, we would still recommend that our clients buy below R16.00, but levels closer to R15.50 would be better. But, of course, this will also depend on how the markets will react. It is pointless to wait too long to win 5% to 8% on the currency but then to miss out on +10% market growth. Entry points are important but trying to time the market usually hurts clients a lot more in the long term. We are, therefore, advising our clients to wait for at least R16.00, and from there to start deploying their cash strategically. Please speak to us, your trusted financial partner.

Household income and the real cost of higher fuel prices

Dr Francois Stofberg
Senior economist and head of sales: Efficient Private Clients


In June, BankservAfrica released another set of dismal monthly salary data for South Africa (SA). The Take-home Pay Index (BTPI) showed that, during the month of May, the average real monthly salary (removing the effect of inflation) in SA was only R14 696; this plummeted by 6.7% since May 2021. In real terms, the average salary has declined from R16 142 in January 2021 to R14 696 in May 2022. A decline in salaries paid to individuals is, of course, horrible, but it does not tell the whole story.

The main reason why average salaries are declining is because our economy is not growing fast enough, and load shedding is a major contributor. By our estimates, the economy could have been at least 8% to 10% bigger by now, with 1.2 million more jobs, if Eskom had not often sent us into rolling blackouts since 2008. But load shedding is not the only culprit. Poor, unaccountable leadership – which translates into corruption, inefficient policies, and a substandard government at all levels – is the main culprit. That being said, the average salary is also declining because more jobs are being created. In May 2022, 98 738 more households had jobs than the year before, the highest monthly year-on-year increase since 2018. The bulk of new employment opportunities was created in the lower-income brackets, people who earn up to R5 000 per month, suggesting the ongoing return of casual and weekly workers. We believe that this trend is welcome news because it should reduce some of the social tension that has been brewing underneath the surface, and showing up in strikes and civil unrest.
Initially, after the first quarter of 2022, we finally saw the economy recover back to pre-pandemic levels. But unemployment was at record highs. This meant that the rich were getting richer and the poor, poorer – a trend that government was to be blamed for, more so than anyone else. Fortunately, as the economy continues to stabilise in this new global environment, it seems that businesses are, once again, starting to employ lower-skilled and seasonal workers, which should continue to redistribute income towards poorer households. Unfortunately, this remains a short-term solution, because no one can live a sustainable life if their average real salary keeps on dwindling. In the long term, we must return to a healthy, vibrant, growing economy.

You may ask what is up with inflation? Real wages are also declining more rapidly because inflation keeps on rising. But compared to the rest of the world, especially developed economies, we do not have an inflation problem. The United States and rich European countries have an inflation problem: There, inflation is at levels that are four times higher than the average long-term rate. In SA, we have barely breached the upper limit of the South African Reserve Bank’s target range of 3% to 6%. Higher than expected fuel and food prices do not mean that total inflation is also extremely high. Food prices, which increased by 7.8% on a year-on-year basis in May, only constitute 15.70% of the average household’s total spending. If we use BankservAfrica’s data, this means that the average household is only paying R370 more each month for food than they were doing a year ago. Fuel prices only constitute 4.82% of the average household’s total spending and increased a staggering 32.5% year-on-year. When we only consider the fuel price increase, we wrongfully believe that the impact on a household’s budget should be enormous. But, because it is such a small share of a household’s spending, the average household is only spending about R470 more on fuel each month compared to a year ago; it is bad, but definitely not as bad as the media is making it out to be.
Of course, these are only averages and the impact might be worse for your household. So, the best thing a household can do in these uncertain times, where interest rates and inflation are rising, and there is a probability of a recession and/or a market correction occurring, is to plan accordingly. Do so by speaking to your financial advisor today!

Inflation and the unlawfulness of cadre deployment

Dr Francois Stofberg
Senior economist and head of sales: Efficient Private Clients


Statistics South Africa (Stats SA) reported last week that, during the month of May, household prices increased by roughly 6.5% year-on-year. Higher inflation was partly driven by a low base effect, but more so by higher fuel prices, which have been increasing owing to the ongoing war in Ukraine as well as the sanctions imposed by the West. Fuel prices in May of this year are 32.5% higher than they were a year ago. Electricity prices are up 14.4%, public transport is up 12.5%, and different foodstuffs are up by roughly 8%. Core inflation, a reading that excludes the more volatile items, such as energy, fuel, and foodstuffs, from the (headline) inflation reading, only increased by 4.5% on a year-on-year basis. This reading helps to show that inflation in South Africa (SA) is a supply and not a demand issue. For this reason, interest rate decisions made by the South African Reserve Bank (SARB) cannot do much to reign inflation in, as higher interest rates cannot do anything to bring down fuel prices, electricity prices, or food prices. Also, if you strip out these volatile prices, it becomes quite clear that we do not have an inflation problem in SA, even though headline inflation breached the SARB’s target of between 4% and 6%. The United States (US), like many other developed countries, has an inflation problem. There, demand has been stimulated by more than a decade of easy monetary policy, which has now resulted in prices going up to levels four times higher than their long-term average rate: 8.6% relative to their long-term average rate of around 2%. The SARB is simply increasing interest rates because they must. If they do not, our markets will not be competitive enough to attract short-term capital, which will put too much strain on our local currency.

Many still believe that the SARB will increase interest rates by another 1% to 1.5% in 2022, and then by another 1% to 1.5% in 2023, or maybe even more. But the SARB might not have to increase interest rates for too long. Amidst fears of a potential recession, international investors last week started to price in a potential slowdown in the tempo of interest rate increases in the US. In his two-day testimony to Congress, US Federal Reserve (Fed) Chairman, Jerome Powell, explained that a recession was “certainly possible”. Global concerns about a slowdown in demand also helped to bring down oil prices to less than $110 a barrel. We expect that this trend will continue and that we might even see oil back to $95 a barrel by the end of the year. This, together with our expectation that the rand will strengthen back to levels between R15.00 and R15.50 against the US dollar, would mean that fuel prices should recover considerably towards the end of the year.

In other welcome news, Chief Justice Raymond Zondo found that the cadre deployment policies implemented by the ruling African National Congress (ANC) are both unlawful and unconstitutional. We have shared a similar view for a long time. High-ranking positions in all spheres of government should be filled based on ‘best for the job’ and ‘best for the country’, not based on ‘best for the party’ or ‘best for my pocket’. Zondo’s report explained that cadre deployment could be abused and lead to corruption and state capture, something that we are all too aware of. By President Cyril Ramaphosa’s own admission, the Deployment Committee previously appointed unfit or corrupt individuals to positions of power. Ramaphosa’s statement undermines evidence that he previously gave regarding the general integrity of the Deployment Committee and its actions. The fact that the committee did not prevent the appointment of unfit or corrupt individuals is an indictment of either its integrity, its ability, or both.