American investment bank backs South African stocks and bonds

Morgan Stanley is positive on South African assets as headwinds from the Iran war fade, arguing that an approaching end to interest-rate hikes and further credit-rating upgrades will provide support.

South Africa entered the second half of the year with softer growth, higher inflation and a more hawkish South African Reserve Bank after the US-Israeli attack on Iran triggered a surge in oil prices.

While those developments have clouded the short-term outlook, they haven’t fundamentally altered the medium-term investment case, according to economist Andrea Masia.

“South Africa’s growth profile looks more uneven and susceptible to downside risks in the near term,” he said in the bank’s third-quarter macro outlook.

“But beyond the next quarter or two, we see tailwinds from an improving supply side, lower inflation, monetary easing and faster credit extension.”

Morgan Stanley still expects the central bank to raise rates by a quarter point at its July meeting to 7.25%, which will be the peak of the tightening cycle.

However, the recent moderation in energy prices, along with inflation approaching what it expects will be a peak of about 4.8% in June, has strengthened the case for policymakers to pause instead, it said.

“Our base case remains for a 25 basis-point hike,” Masia wrote. “But credible arguments for a hold have emerged.”

The investment bank sees rates being lowered to 6.25% by the end of 2027, helping to support better financial conditions.

Morgan Stanley’s most constructive view is of the domestic bond market.

It expects improving public finances to help shrink South Africa’s risk premium — the richer returns that investors demand for holding the nation’s debt.

The picture will be brightened by better-than-expected tax revenue generated by higher commodity prices and government debt stabilising as a share of the economy, putting South Africa on track for additional credit-rating upgrades.

Those factors, together with elevated inflation-adjusted interest rates, support a bullish steepening of the yield curve.

The bank’s optimism was more restrained when it came to the rand.

While stronger fiscal fundamentals offer medium-term support, Morgan Stanley sees persistent dollar strength, moderating precious-metal prices and uncertainty surrounding South Africa’s local government elections later this year as potential headwinds that prevent it from being more confident about the currency.

On the economy, Morgan Stanley expects South African growth to pick up once the current energy-price shock fades, helped by lower inflation, SARB rate cuts, improving electricity supply and stronger lending.

It sees the economy expanding by 1.2% this year and 1.6% in 2027. But that’s unlikely to lift South Africa onto a materially faster long-term growth path.

Morgan Stanley estimates the economy’s potential growth rate remains capped at about 1.4% because investment is still too weak, limiting its willingness to become a long-term bull on corporate earnings despite an improving cyclical backdrop.