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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.

Financial Markets Just Plunged, What Must I Do With My Investments?

For the last few days financial markets around the world have taken a massive beating, and this has affected investment portfolios severely. Some investment gurus are calling it the end of a very long bull run while others are calling it a technical correction.

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Volatility Creates Opportunities

Whilst global economic growth remains strong and global unemployment remains low, the markets fear that global central banks will raise interest rates too quickly resulting in a recession. Conversely, not raising interest rates enough might allow inflation to become entrenched.

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Should I Stay Invested?

During 2022, market sentiment was negatively impacted by events such as the war in the Ukraine, Covid, higher inflation and interest rates. Global equities fell by 15% year to date ending May 2022. SA asset classes were more resilient due to higher commodity prices. Although growth assets such as equity and property underperformed during 2022, these asset classes are required to outperform money market funds over the long term as illustrated in the table below.

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What investors should do as volatility increases

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

Even after increasing interest rates by 0.75%, the United States (US) Federal Reserve (Fed) still believes that it is possible for the central bank to achieve a soft landing in which they can tame inflation without pushing the economy into a recession. Consumers, however, seem to disagree, and this is in line with economic data showing the worst reading of consumer confidence since the 1970s. From the comments made by the Fed Chairman, Jerome Powell, it seems that the Fed believes that a successful policy outcome would be if unemployment increases from 3.6% to 4.1% while inflation returns to 2% over the next two years. Even though investors had not seen such a rapid increase in US interest rates since 1994, they reacted positively to the news, mostly because it shows that the Fed is serious about fighting inflation. Theoretically, lower inflation is necessary in developed economies to have a healthy labour market in terms of real wage gains.

The Fed also signalled that more interest rate increases would be needed in 2022. Last week’s 0.75% increase brought the short-term borrowing costs to a target range between 1.50% and 1.75%. The median Fed policymaker expects further increases up to roughly 3.4% by the end of the year. That would suggest another 1.75% in total rate hikes, spread across the remaining four scheduled Fed meetings in 2022. In March, experts believed that it would only be necessary to increase rates to 1.9%. But since then, the Fed has increased their inflation forecast for 2022 from 4.3% to 5.2% and decreased their economic growth forecasts from 2.8% to 1.7%.

Overall, the S&P 500, a stock market index that tracks the performance of 500 large US-listed companies, has seen its second-worst year-to-date performance in its history. Only during the Great Depression of the 1930s has this index seen a larger contraction, 39.2%, compared to this year’s 21.6% contraction. Riskier asset classes, like cryptocurrencies, have seen even greater contractions. Since its high in November 2021, around $69 000, the price of Bitcoin has contracted by almost 70%. Overall, the market capitalisation of the cryptocurrency market has fallen from around $2.97 trillion, down to $900 billion. Cryptocurrencies were hit hard this week after US crypto lender, Celsius, froze withdrawals and transfers between accounts. Fears are mounting around the potential for a wider fall out in digital asset markets, which were already shaken by the demise of the TerraUSD and Luna tokens last month.

But what does all this uncertainty mean for investors? Is this the time to panic-sell and put all of your money into cash? Definitely not! Markets reward investors for their time, thus trying to time the markets can cause a lot more harm for investors. The reality is that we are all exposed to market volatility, in some way or another. The best we can do is to plan accordingly, something your financial advisor can assist you with, and to stick the course. As an example, if you are retired, a silo approach will protect your investments because you do not have to sell out of your equity positions. You can continue to draw an income and wait for markets to set new all-time highs. If you are not retired yet, market corrections like these provide a unique buying opportunity where investors can acquire assets at substantially reduced prices. Investors should, therefore, rather attempt to acquire more assets now.

A resilient rand

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

 

The rand has remained resilient, albeit volatile, as negative global drivers continue to clash against many positive local drivers. At one point, the rand touched R15.18 last week, before poor performing global indicators caused the rand to depreciate back to levels around R15.90. But, excluding the rumours that President Ramaphosa might have to step down, the multitude of positive local factors caused the rand to close last week off at R15.36. On a side note, we still believe that long-term investors who want to get into global markets should take their money offshore at levels below R15.50.

Globally, the European Central Bank (ECB) announced that they would start to increase interest rates for the first time since 2011. Following the guidance provided by the ECB, July should see rates in the European Union (EU) increase by 0.25%, from the current rate of -0.50% to -0.25%. If inflation does not slow down sufficiently, the markets expect the ECB to follow this initial increase up with a 0.50% increase in September. How the ECB will use quantitative tightening to reduce their balance sheet and to attempt to keep the yield curve from inverting, remains to be seen. Unlike the United States (US) Federal Reserve (Fed), if the ECB makes changes, 19 countries are directly impacted and, unfortunately, these countries are on different ends of the spectrum of what is considered a healthy economy. On the one end, Germany seems able to stomach increases with a smile but, on the other end, Italy and Greece might already be fearing recessions.

In other disheartening global news, the Organization for Economic Co-operation and Development (OECD), an intergovernmental agency positioned to stimulate economic progress and world trade, sharply reduced their global growth forecasts for 2022, and almost doubled their inflation forecast. The OECD now believes that the global economy will only grow by 3.0% during 2022, down from their 4.5% forecast in December 2021. Inflation, they believe, will, on average, increase around 9% among their member states this year. The World Bank reduced their global growth forecast to 2.9%, even though China continues to support their economy’s growth. More good news from China was their regulatory approval of dozens of new video games. Markets are hopeful that it might signal the end of the long-running and painful crackdown on the sector, which has even set rules about how many hours children are allowed to play video games in China. The good news from China was, however, quickly snuffed out by record-high inflation in the US. Many were hoping that US inflation peaked at 8.5% in March and were surprised when government authorities announced that inflation accelerated beyond expectations to 8.6% in May. We should, therefore, see the Fed increase interest rates by 0.5% during their June and July meetings, while markets remain under a tremendous amount of pressure. If these increases can cool the economy off enough, we might see the Fed relent, a bit. If not, the Fed will continue to increase interest rates by 0.5%.

In South Africa (SA), however, and unlike the trend that we have seen over the last couple of years, good news economic stories have been rolling in: The gross domestic product (GDP) came in higher than experts expected. During the first quarter of 2022, the South African economy grew by 1.9%, measured against the previous quarter, which only grew by 1.2%. By implication, the size of the economy, now roughly R4.62 billion in real terms, is finally higher than it was pre-pandemic. In our view, the South African economy should grow by about 1.6% in 2022, as lower local and global demand take their toll. Quite surprising was the 3.6% increase in gross fixed capital formation (GFCF), which has been lagging for many years and is crucial for long-term sustainable wealth creation. Higher GFCF numbers mean that there are more long-term investments being made in SA, which points towards a positive shift in economic sentiment. More good news is that, during the first quarter of 2022, the surplus on the current account of the balance of payments widened to 2.2% of the GDP, R143 billion, from R132 billion in the fourth quarter of 2021. The current account measures SA’s transactions with the rest of the world, and a surplus means that more money flowed into the country than out of it. More money flowing into SA supports our financial account and increases the demand for rands, which helps to keep the rand strong.