Why the Reserve Bank has eyes on the United States and China

[Nat Quinn]

 

 

While the South African Reserve Bank (SARB) has said time and time again that it bases its policy decisions on a host of independent data, economists say the reality is that the bank is heavily tied to what happens with the United States Federal Reserve.

The SARB’s Monetary Policy Committee is meeting this week to determine the next move for interest rates in South Africa.

There is wide consensus that the bank will hold the repo rate at 8.25% once again.

However, the markets are becoming more optimistic that the cutting cycle will start soon: for some, as early as September’s meeting and almost assuredly in November for others.

This is despite the SARB saying at the May meeting that South Africa’s inflation outlook is likely to only hit its target in mid-2025 and its own forward projection models pointing to a start in the cutting cycle at the start of next year.

The confidence that the cutting cycle will start soon is based on sentiment around the US Fed – where markets are betting on its first cut happening in September.

Investec chief economist Annabel Bishop has noted several times that the SARB is unlikely to ever cut rates ahead of the US, as this would weaken the rand.

“A delay in interest rate cuts in South Africa and a quickening in the start of the US interest rate cutting cycle would widen the differential between South African and US interest rates, which would add to rand strength,” she said.

Economists at Bank of America have also softened their projections for rate cuts based on the turn in sentiment around the Fed’s next move. The group says that rate cuts for South Africa in September and November are more likely if the Fed cuts first.

In fact, it’s almost impossible not to find a projection on the path forward for interest rate cuts that is not heavily reliant on what the Fed does next.

When the Fed expresses sentiment that indicates rates will stay higher for longer, local projections are pushed back, and the rand weakens. When the Fed indicates that cuts might come sooner, local views are brought forward, and the rand gets stronger.

Tale of two markets

According to Old Mutual Wealth Investment Strategist Izak Odendaal, the SARB—and so many other central banks—are tied to what happens to the US because capital tends to flow where risk-adjusted returns are the highest.

The US is a massive capital market, and the health of that market determines the flow of investment. However, the US is not alone in its influence; the Chinese economy is also involved in the tug-of-war.

Globally, central banks have been monitoring the economic recoveries in the US and China, particularly their very different inflation profiles, to determine their impact back home.

Odendaal noted that if the US Fed embarks on a cutting path, it will not only relieve pressure on fragile sectors of the US economy, but also elsewhere in the world, including China—the world’s biggest single export destination.

The challenge for central banks, Odendaal said, is that they need to set interest rates today that will impact the economy in the future, based on data from the past.

A pattern that has emerged worldwide—including South Africa—is that central banks set interest rates with only one eye on domestic inflation and economic dynamics and the other squarely focused on the Fed.

“South Africa is geographically far away from both the US and China. However, what happens in these two giants probably has a greater impact on local investors than decisions made in the Union Buildings in Tshwane or the Parliament in Cape Town,” he said.

“The US has an outsized impact on financial markets, while China is the largest single export destination. To the extent that the two giants pull in different directions in the years ahead, countries like South Africa will face tough choices.”

Odendaal said that South Africa could reap benefits from its relationship with both superpowers if it is able to engage in skilful diplomacy.

However, in the near term, the story looks more positive.

“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, if not this week, then at its next meeting,” he said.

 

source:Why the Reserve Bank has eyes on the United States and China – BusinessTech

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