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A friendly glance at crypto-“currencies”

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

The Financial Sector Conduct Authority (FSCA) recently said that it will soon publish the regulatory framework for cryptocurrencies in South Africa. Many in the industry, especially those who support the technology, have been anxiously awaiting this legislation for quite some time. Previously, the FSCA was vocal about declaring cryptocurrencies as financial products and this past week the Prudential Authority Division at the South African Reserve Bank (SARB) shared a similar sentiment. The Prudential Authority also asked banks to work with crypto exchanges instead of simply closing their accounts.

We maintain that more regulation is needed in the cryptocurrency space to protect consumers against all of the scams that we have read so much about during the last couple of years. Only with effective legislation can this superior technology be adopted by the masses. And it truly is superior. Even in its infancy, the cryptocurrency environment is allowing for faster and safer transactions worldwide, often at no cost. The environment also allows markets to be open 24/7, which means that consumers always have access to liquidity. With blockchain technology, the backbone of cryptocurrencies, you do not have to wait two or more days for money to reflect in your account – most of the time it happens instantly. But there are, of course, many other benefits of having a market that is always open. The cryptocurrency market also has fewer foreign exchange controls, which means that no one can tell you what you are allowed to do with your money; a key concern for regulators, of course. Another benefit of some cryptocurrencies is that they allow for decentralisation. This characteristic allows the collective to govern themselves without handing their sovereignty over to the government. But with these and other efficiencies, the technology can also be exploited for the wrong reasons, and it is for this exact reason that clever regulation is needed.

We are still unsure how local regulators will classify and treat this unique asset class. One of the main difficulties that regulators face is the fact that not all cryptocurrencies are the same, so regulation must be more fluid, a characteristic that regulators are not always known for. Precisely because cryptocurrencies are different, it is more appropriate to refer to them as tokens, coins, or even digital assets. Bitcoin, the most widely known and adopted token is, for all intents and purposes, not a currency. Like gold, it is considered to be a store of value because of its limited supply. That being said, its price volatility does not qualify it as a store of value in the traditional sense. Some tokens, like Litecoin, are used as currencies because transactions are fast and cheap. Others are backed by fixed assets: Many of the stable coins are backed by a combination of fiat currency and even bonds. Yet others, like Cardano or Solana, are backed by specific projects and fulfil another function entirely. In this case, they use blockchain technology to execute smart contracts that allow them to build the infrastructure that is needed for things like Web 3.0. And then there are tokens that act like normal shares. Binance, a digital asset exchange, for instance distributes some of their profits towards those who hold the Binance token.

Each of these characteristics, collectively referred to as ‘tokenomics’, makes the token unique and desirable. For this reason, if regulators want to effectively regulate these digital assets, they must differentiate between specific groups of tokens and apply rules appropriately. In the past, Africa has been a leader in terms of creating and adopting financial technologies, like cell phone banking, and our regulations have, in many ways, allowed for the successful adoption of these technologies. We are hoping that we will, once again, lead the way.

 

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US inflation, a slump, and a final buying opportunity

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

Investors breathed a sigh of relief last week after data from the United States (US) Department of Labor showed that US inflation finally eased from its four-decade high. The Consumer Price Index (CPI), an index used to measure the rate of price increases among households, came in lower than analysts expected: It increased 8.5% from a year earlier, cooling off from the 9.1% high that we saw in June.

The below-forecast reading came on the back of a sharp drop in energy costs and provided a much-needed boost to risk assets globally. Oil prices have now fallen to $97 a barrel as concerns about a recession have reduced demand expectations to below their pre-Ukraine war levels. Lower oil prices were also supported by data showing that US oil stockpiles were at their highest levels since December 2021, thanks to an increase in domestic output. Globally, a tight oil market saw some relief when a dispute linked to sanctions was resolved, allowing oil to flow from Russia to three European countries.

Investors are hopeful that the slowdown in inflation is a sign that inflation has, in fact, peaked and that the US Federal Reserve (Fed) will need to raise interest rates less sharply to keep inflation under control. Markets are now pricing in a 37.5% chance that the Fed will increase interest rates by 75 basis points for a third consecutive time at its September policy meeting; a 50-basis points increase is now the more likely option.

Expectations around less aggressive interest rate increases caused the dollar to lose further ground against other major currencies. This was welcome news for emerging market currencies like the rand, which ended up around R16.27 against the US dollar after appreciating to R16.14, its strongest level since the end of June. This is also much stronger from the slump we saw in July when the rand sank to a low of R17.24.

For now, the US economy remains resilient, producing jobs despite higher borrowing costs and inflation, which is quickly deteriorating the buying power of households and businesses. But while sentiment was positive, analysts warned against getting over-excited as inflation was still high and would take some time to get under control. If we were to take a step back, other global economies are faring a lot worse. World markets have been battered by a range of other issues, including the war in Ukraine, supply-chain snarls, and rising China/US tensions over Taiwan, to name but a few.

For now, we agree with the decision of many to de-risk their portfolios, especially if you are dependent on their income. Global markets might see another round of corrections in the next few months. But we would not have our clients sit on their hands for too long. In fact, this time should rather be used to sort out admin and get cash ready. If there is another slump this will provide long-term investors with the perfect buying opportunity, one which they might not see again for a long time to come.

Another emerging market crisis? This time it is different…

Renier van Zyl, CFA

Portfolio Manager: Efficient Private Clients

Millennials and Generation Z are unlikely to remember that, back in 1997, Asia was dealt a significant blow by the United States (US) Federal Reserve (Fed), who, through their actions, caused the US dollar to appreciate substantially. Halfway around the world it was July 1997 and monsoon season was on its way in Thailand, but that year the country’s currency, the baht, would experience a monsoon of a different kind. When the US Fed raised rates in 1997 to fend off increased inflationary pressures, the Thai baht’s peg* snapped against a very strong US dollar. This led to a series of currency crashes, one after the other, across emerging markets (EMs), such as Indonesia, South Korea, and Russia. What happened to the baht, however, was not an anomaly, as similar events led to the Latin American debt crisis of the 1980s and the Mexican crisis of 1994. This begs the question whether EMs and the rest of the world are in for another round of pain as the US Fed battles eye-watering levels of inflation.

But what is needed for an EM crisis? In each of the above-mentioned cases, capital flooded into these markets before the events even started. With their coffers full of cash and most of the debt denominated in US dollars, all that was needed for a financial calamity was for someone to turn up the heat: In came the US Fed with their monetary policy tools and out went most of the capital. This, in turn, highlighted underlying EM problems, such as weak balance sheets, poor regulations, rocky financial systems, etc. Whilst some of the afore-mentioned problems were plain to see before the events played out, it would be naïve to assume that anybody could see the crisis coming, which speaks to the very core of what a crisis is.

Today, investors and economists might scratch their heads and wonder whether Mark Twain was correct when saying that “history never repeats itself, but it does often rhyme”, especially when they assess the current events in Sri Lanka and Argentina. I cannot blame them as these fears are exacerbated by everyday headlines that emphasise slowing global growth as well as the impact of elevated food and fuel prices on companies and individuals around the world. But, upon closer inspection, things look very different compared with two decades ago.

For one, fewer EMs have dollar pegs (like the one that Thailand had) today than ever before. In addition, EMs are less dependent on international financial institutions for financing: Only about 60% (down from 80% in 2006) of financing comes from the International Monetary Fund (IMF). China has replaced a large part of this financing and has become such a large lender to other EMs that its lending habits rival that of the World Bank in scale. And then finally, the countries most at risk of defaulting on their debt today only account for 5% of the global gross domestic product (GDP) and 3% of global public debt, figures much lower than two decades ago.

A bigger threat to global and EM stability today is China, where non-financial sector debt has risen at a breakneck speed since 2008. For now, a silver lining to China’s debt problem is that foreign investors hold only about 11% of Chinese sovereign debt, and with interest rates still relatively low, China still has some room to manoeuvre. Investors must, however, know that the situation can change quite quickly. It would, therefore, be prudent for countries who recently applied for BRICS membership and are struggling with their own woes, such as Iran and Argentina, to not consider China as their saving grace.

Whilst investors might be concerned about how the situation is unfolding in the world right now, it is important to remember that the probability of another EM crisis seems a lot lower than in the past. Also, the impact would almost certainly be more limited than before.

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.

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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.