The final month of 2023 was dominated by fluctuating interest rate expectations and investors continuing to speculate when rate cuts may begin. While this led to a relatively cautious mood at the start of the month, Federal Reserve Chair, Jerome Powell, indicated in mid-month that the Federal Open Market Committee (FOMC) had pivoted towards a more dovish stance, ending its historic policy tightening campaign. This paradigm shift ignited one of the biggest post-meeting rallies across assets in almost 15 years. The combination of pending rate cuts and recent data out of the United States (US), which showed that the economy remains resilient, bolstered expectations of a “soft landing” for the US economy. As at the close on 15 December, US markets were sharply higher for the month, with the S&P 500 Index trading 3.4% higher. The MSCI World Index (+3.5%) was able to maintain upward momentum, with the MSCI Emerging Markets Index offsetting earlier losses to trade up 1.5%.
A similar situation unfolded in Europe (EuroStoxx 600 Index: +3.3%) with investors turning their attention to monetary policy announcements from the European Central Bank (ECB) and Bank of England (BoE), with both keeping interest rates unchanged. ECB President, Christine Lagarde, cautioned that the fight against inflation was not over, despite the recent slump towards the 2% level, weighing on hopes for early rate cuts next year.
Chinese markets lagged global peers with the MSCI China Index trading down 3.1% as mixed economic data, growth concerns and geopolitical tensions weighed on investor appetite for equities in the region. In addition, ratings agency Moody’s placed the credit ratings of several Chinese Local Government Financing Vehicles (LGFVs) on review for downgrade after cutting its outlook for the country’s sovereign bonds to negative from stable. It noted that a combination of increases in direct and indirect debt burdens, stressed liquidity conditions for some of their LGFVs and local State-Owned Enterprises (SOEs), and/or relatively weak economic prospects as reasons for their more cautious stance. This raised further concerns and supported the continued dim outlook on the Chinese economy despite government efforts to bolster growth.
Locally, the All Share Index was able to offset earlier losses as well following the shift in global sentiment, trading almost flat at the time of writing, with the rand also seeing improved levels against the US dollar. In terms of local data, Consumer Price Inflation fell to 5.5% y-o-y in November from 5.9% in October, in line with expectations. The moderation was mainly due to lower fuel prices which offset rising food prices – further improvements are expected, particularly at a headline level, with fuel prices set to decline further and supply side impacts on food prices waning into next year. Demand in the economy, however, is set to remain weak, weighing on core inflation. We also anticipate that the South African Reserve Bank (SARB) will keep interest rates on hold in January 2024.
Economic Data Review
The US Federal Reserve finally pivots with at least three rate cuts expected next year
Flash estimates showed that the S&P Global Composite PMI for the US held steady at 50.7 in November, slightly higher than expectations. This indicated a marginal further expansion in private sector activity. Although manufacturing firms reported a slower pace of expansion, service providers witnessed a fractional uptick in output growth, the fastest since July. Retail sales in November increased 4.1% y-o-y - this was better than expectations. The US trade deficit widened to $64.3 billion in October 2023, against forecasts of $64.2 billion, as exports were down 1% and imports increased 0.2%. The unemployment rate in November fell to 3.7%, below market expectations. The annual inflation rate in the US slowed to 3.1% in November 2023, the lowest reading in five months, and in line with forecasts. The Federal Reserve kept the benchmark rate steady, as expected, for a third consecutive meeting in December 2023 but indicated 75bps cuts in 2024. Policymakers said that recent indicators suggest that economic growth has slowed, and job gains have moderated but remain strong with the unemployment rate remaining low. Inflation has eased over the past year but remains elevated.
The ECB kept rates on hold but warns that policymakers shouldn’t become complacent
On a preliminary basis, the HCOB Eurozone Composite PMI rose to 47.1 in November, up from a near three-year low of 46.5 in the previous month and slightly above market expectations of 46.9. It was the highest PMI reading since July but still indicated a notable deterioration in economic conditions. Retail sales fell by 1.2% y-o-y in October, the third consecutive month of contraction, but in line with market expectations of a 1.1% decline. A trade surplus of €10 billion was recorded in September, compared to forecasts of a €22.3 billion surplus, swinging considerably from a €29.8 billion gap in September 2022, largely due to the stabilisation in prices of natural gas and other major resource imports into the currency bloc. The unemployment rate increased to 6.5% in October, unchanged from September and matching market forecasts. Inflation for November came in at 2.4%, falling below consensus expectations. The ECB kept interest rates unchanged (as expected) for the second consecutive meeting, to address high inflation despite a slowdown in economic growth. The focus now turns to President Lagarde's comments, particularly regarding her acknowledgment of the unexpectedly rapid decline in inflation and the ECB's stance on speculations of potential interest-rate reductions.
The BoE remains cautious and reiterated that monetary policy is likely to be restrictive
The S&P Global/CIPS UK Composite PMI rose to 50.1 in November, up from 48.7 in October and above market expectations of 48.7 according to preliminary estimates. Retail sales decreased 2.7% y-o-y in October, compared to forecasts of a 1.5% drop. The trade deficit widened to £4.48 billion in October 2023, compared to expectations of a £1.7 billion deficit, the largest in five months, as imports jumped 4.6% to a four-month high and exports rebounded 0.6% from a one-year low. In line with market expectations, the unemployment rate was unchanged at 4.2%. Annual inflation in the UK dropped to 4.6% in October, down from 6.7% in both September and August, falling below market expectations of 4.8%. The BoE maintained its benchmark interest rate at a 15-year high of 5.25% (as expected) for the third consecutive time during its December meeting, aligning with policymakers' efforts to combat inflation, even in the face of indications pointing to a deteriorating economic landscape. Three members advocated for a 25bps rate hike, citing the relatively tight labour market and evidence of persistent inflationary pressures. The central bank emphasised the necessity for an extended period of restrictive monetary policy to curb inflation, while also highlighting the potential requirement for further tightening should inflationary pressures persist. Despite these statements, investor forecasts anticipate a decline in UK interest rates next year. They have adjusted their bets on the extent of rate cuts, with the first fully priced in for June instead of May.
China concerns dominate sentiment once again
China’s composite PMI fell to 51.6 in November 2023 from 50 in October. This was the 11th straight month of growth in private sector activity and the steepest pace since August, as factory activity unexpectedly expanded following a fall in October, while the service sector rose the most in three months. Retail sales surged by 10.1% y-o-y in November, much faster than a 7.6% increase in the previous month and compared with market consensus of 12.5%. China's trade surplus increased to US$68.39 billion y-o-y in November 2023 compared to $66.49 billion in November 2022, easily beating market forecasts of $58 billion, as exports unexpectedly grew while imports surprisingly fell. The surveyed urban unemployment was unchanged at 5% in November. China's consumer prices fell by 0.5% y-o-y in November 2023, steeper than a 0.2% drop in October and compared with market forecasts of a 0.1% fall. The People's Bank of China (PBoC) maintained lending rates in November, as was widely expected. The decision came after the central bank held medium-term interbank rates steady as economic activity in October was mixed, with headwinds from the property sector deepening despite many stimulus measures from authorities. Meanwhile, a weakening yuan continued to limit the scope of monetary easing. China remains an outlier among central banks, having loosened monetary policy to revive a faltering economy but further rate cuts would widen the yield gap with the US, risking yuan depreciation and capital outflows. Some economists expect the board to slash the lending benchmark by 20bps at the end of 1Q24.
Market participants expect the BoJ to start unwinding its ultra-loose monetary settings
Early estimates showed that the Jibun Bank Composite PMI increased to 50.4 in December 2023 from a final 49.6 in November. A stronger rise in services activity supported the upturn, offsetting a quicker fall in factory output. Retail sales rose 4.2% y-o-y in October, slowing for the second consecutive month following a revised 6.2% gain in September. October’s figure was also the lowest reading in 10 months and came in way below market expectations for a 5.9% rise. Japan’s trade deficit narrowed sharply to ¥662.55 billion in October from ¥2.205 billion in October 2022, less than market estimates of a shortfall of ¥735.7 billion. The unemployment rate fell to 2.6% in September from 2.7% in August, in line with expectations. The annual inflation rate rose to 3.3% (above expectations of 3.2%) in October from 3% in the prior month, pointing to the highest print since July. The BoJ kept its key short-term interest rate unchanged in October, in line with expectations, with market forecasts guiding for a similar outcome at the final meeting for the year. In a quarterly outlook report, the BoJ revised inflation forecasts higher for FY23 and FY24. Meantime, policymakers noted that Japan's economy was likely to continue recovering moderately, supported by pent-up demand but highlighted downward pressure from a slowing global recovery. The board reiterated that it will not hesitate to take extra easing measures if needed.
Local inflation eased in November with expectations of interest rates remaining on hold
The SACCI Business Confidence Index for November increased to a nine-month high of 111.5 (compared to a reading of 108.6 in the previous month), with sentiment driven by a more positive outlook on tourism and foreign trade relations (including merchandise volumes). Mining production recovered almost 4% y-o-y in October (against expectations of a 1.5% increase), marking the first uptick in activity after more than three months, as output for PGMs, manganese ore and chromium ore improved. Manufacturing production grew 2.1% y-o-y, ahead of the expected increase of 1.8%, signalling a swift rebound in activity, with strong contributions from petroleum, chemical products and rubber & plastic producers. The composite PMI improved to 50 in November (compared to 48.9 in October), pointing toward a stabilisation in private sector activity amid robust domestic demand. The manufacturing PMI increased to 48.2 (October: 45.3). Total new vehicle sales decreased to 45 075 units (October: 45 460 units) as buyers remained under pressure due to tight economic conditions.
Consumer Price Inflation (CPI) eased to 5.5% in November (against forecasts of 5.6%) amid moderating transport (fuel) costs, notwithstanding sustained pressure in food & non-alcoholic beverage prices. This remains within the SARB’s target range of between 3% and 6%. Core inflation (which excludes the price of food, non-alcoholic beverages, fuel and energy) was slightly higher at 4.5%.
During its November meeting, the SARB left its benchmark interest rate unchanged at 8.25% (in line with expectations) and emphasised that inflation risks remain elevated though the risks for medium-term domestic growth appear balanced. The SARB’s main goal remains to firmly anchor inflation expectations around the midpoint of its targeted range.
Outlook
Local
- We predict growth of 0.8% in 2023, lifting to 1.2% in 2024, 1.6% in 2025 and 1.8% by 2026. The near-term growth projection has improved on a lower intensity of load-shedding, while growth in the medium term continues to rely on the structural reform agenda and improving external demand. We remain concerned that further escalations in geopolitical tensions will hinder improvement in global trade and the reversion of inflation to central bank targets.
- Furthermore, we are worried about mounting stress for vulnerable households. Cost-of-living pressures and failing service delivery have likely pushed many households into distressed borrowing, which will have implications for borrowing costs as a proportion of disposable income and the overall health of balance sheets. Next year will likely remain challenging but as inflation slows and economic growth gains momentum, we are likely to see more pronounced and broad-based employment and real wage growth.
- Slower inflation is a key feature of the medium-term outlook but the risk is material that it is more sticky than projected. Currency and supply-side pressures continue to manifest themselves in elevated goods inflation, although to a lesser extent with the unwinding of international supply chain bottlenecks, but services highlight weak consumer demand. In line with this, core inflation generally underwhelmed expectations this year, indicating that the passthrough of elevated input costs has been constrained. This supports average annual headline inflation slowing to 5.9% in 2023, from 6.9% in 2022, before falling to 4.7% in 2026.
- Weak demand-driven inflation is consistent with restrictive monetary policy. With nominal interest rates at 8.25%, and inflation falling towards 5% by year-end, real interest rates should climb above 3% and exceed the estimated level of neutral by 0.5 ppt. With policy becoming more restrictive as inflation slows and after three consecutive holds by the MPC, we are more confident that we have reached the peak in nominal interest rates. The next major risk event in the calendar is the 2024 elections, after which the MPC should consider cutting rates. Ultimately, the MPC should only look to remove excess restrictiveness but not necessarily shift to an accommodative stance. This will be key to catering for funding risks while ensuring that financial conditions are consistent with inflation slowing to target sustainably.
Global
- Our primary concern going forward is whether the resilience of company earnings can be extrapolated into the future. We believe that this may prove difficult as the lagged effect of tightening monetary policy actions will likely begin to filter through to changes in both corporate and consumer spending patterns. Higher borrowing costs for both businesses and consumers will likely suppress economic activity, particularly in discretionary related areas, as economic agents look to rein in expenditure to tighten their balance sheets and income statements. However, there is potential for fiscal stimulus in an election year (2024).
- Households will likely continue utilising various credit instruments, particularly credit card debt which is currently at all-time highs to prop up short term expenditure prospects. Moreover, the reactivation of over $1.6 trillion of student debt may well present a headwind to future earnings prospects. Nevertheless, if liquidity remains plentiful, the emergence of price discovery in the short-term could be prevented.
- In emerging markets, it is certainly encouraging to see the People’s Bank of China maintaining loose monetary policy and further injecting liquidity into the banking system. However, recovery to remain fragile in the absence of fiscal stimulus targeted at restoring confidence to the consumer or addressing the property sector issues. With low levels of inflation and notable excess savings combined with attractive valuation multiplies, we are of the belief that selected opportunities remain in the Chinese economy and will be on the lookout for more palatable policy responses from fiscal authorities.
- We have continued to reduce the fixed income underweight. We are taking more explicit position on the long end of the curve as inflation continues to trend down. We would look to take an overweight fixed income position when investor fears have shifted from interest rate and inflation to that of growth prospects.