Good news for South African interest rate cuts next month

With the Federal Reserve sending a clear signal that it will begin cutting interest rates in September, there is an increased likelihood that the Reserve Bank will also ease its monetary policy towards the end of 2024. 

Fed chairman Jerome Powell told the media following an announcement that US interest rates would remain unchanged and that cuts could come as soon as September. 

“The question will be whether the totality of the data, the evolving outlook, and the balance of risks is consistent with rising confidence on inflation and maintaining a solid labour market,” he said. 

“If that test is met, a reduction in our policy rate could be on the table as soon as the next meeting in September.”

Notably, sentiment shifted to focusing on “risks to both sides of its dual mandate” rather than prior wording focused just on inflation risks.

The Federal Reserve, unlike the Reserve Bank, has a dual mandate to keep prices stable and ensure full employment in the economy. 

“In recent months, there has been some further progress toward the committee’s 2% inflation objective,” the FOMC statement said.

“The committee judges that the risks to achieving its employment and inflation goals continue to move into better balance.”

While the Reserve Bank closely monitors local inflation data, it also closely watches the movements of the Federal Reserve, as the US is the world’s largest capital market. 

Old Mutual Wealth investment strategist Izak Odendaal explained that the US has an outsized impact on financial markets because of this. 

Thus, one of the reasons the Reserve Bank has kept interest rates at 15-year highs and delayed its cutting cycle is because the Fed has not began to cut its rates. 

Capital generally moves to areas offering the highest risk-adjusted returns, and at present, investors can secure a risk-free 5.5% return with short-term US government bonds.

As a result, the Reserve Bank is cautious about lowering interest rates, as this would diminish the appeal of South African assets compared to their US counterparts. This could lead to a depreciation of the rand and potentially drive up inflation.

Consequently, when the Federal Reserve starts to reduce interest rates decisively, the Reserve Bank will likely act quickly in following suit or may preempt this move if local inflation drops enough.

“The prospect of lower US interest rates is positive for local financial markets and supports the case for the South African Reserve Bank to start lowering its policy rate at its next meeting,” he said. 

Odendaal also pointed out in his latest Investment Note that, from a purely investment point of view, the most important turning point is the global interest rate cycle. 

Most central banks are now in cutting mode, with only a few outliers hiking, such as Nigeria and Russia, while 37 of South Africa’s emerging market peers eased their monetary policy.

As rates decline, there is relief for indebted households and businesses, while new borrowing becomes cheaper, supporting both capital and consumption spending. 

As for financial markets, all else being equal, lower rates support higher equity and bond valuations. 

However, there is one problem with cutting interest rates at this time. If central banks, including the Reserve Bank, cut too deep or too soon, then inflation could flare up again. 

This may result in central banks raising rates to tame another wave of inflation. 

Moreover, global supply chains are still very tightly wound and subject to disruptions. The recent global IT outage grounded several large airlines and was a foretaste of what could go wrong. 

Therefore, it is likely to be a modest interest rate-cutting cycle unless there is a sharp slowdown in economic activity, in which case rates will be reduced quickly. 

The good news is that there is substantial room to cut rates and provide support should this be necessary. It is unlikely that inflation fears will prevent a response to recessionary conditions, which was not the case 12 to 24 months ago.