Good results in the US signal higher interest rates but for Africa it poses a serious obstacle
We are moving into a very difficult phase for monetary policy. On Friday, America’s biggest bank by assets, JP Morgan announced surprisingly good results for the second quarter which it ascribed to improved lending but also a boost from slightly higher short term rates, in other words those rates that impact their spreads.
This is exactly what creates a clear conundrum for us. Seeing that we have to follow closely the monetary policy of South Africa, what we do locallly will have minimal impact on the bigger picture, but what is decided at the South African Reserve Bank, can cause enormous problems for us.
American short term rates are off their lows of between zero and 0.25% but at around 1.1% they are nowhere near the long term average which lies somewhere between 4.5% and 5%. Lately, long term rates have improved but these also remain stubbornly stuck around 2.3%.
Local monetary policy is faced with the painful reality that there is a direct link between local interest rates and the external value of the Rand. If the spread between Dollar and Rand rates becomes too narrow, investment on the Johannesburg Securities Exchange and in South African government bonds tend to lose its appeal for foreign investors, money leaves the Common Monetary Area, and the Rand weakens. Since the South African government does not have the resources to prop up the Rand’s value, it tends to deteriorate when overseas interest rates go above certain levels.
This means, South Africa, and by implication we, have to keep interest rates at a certain level to ensure positive portfolio flows otherwise we see the Rand tanking and everything we import, including most of our fuel, becomes more expensive. The short term interest rate, the so-called repo rate, is the only policy instrument the SARB can manipulate to attract liquidity into the South African market.
By necessity, this implies that if interest rates, both long and short, start rising in the US, local short term rates have to be increased to keep offering an attractive spread.
Enter the latest inflation figures. In South Africa, overall inflation is already down to 4.5% while in Namibia, there is a discernable downward trend since January this year when inflation peaked. So from a conventional monetary policy point of view, decreasing inflation indicates that the interest rate cycle has completed its upward phase, and are due to be lowered.
But that we can not really do, because then we lose foreign portfolio flows and the Rand weakens, and, and, and, and, and!
For the next six months, I believe we will go through a monetary policy phase where any adjustment will have to be carefully synchronised by the Reserve Bank, in consultation with its Monetary Area partners, and with a keen eye on the Rand’s external value.
We have seen in 2006 and 2007, just before the onset of the international financial crisis, how quickly so-called carry trades can unwind when local interest rates do not support portfolio investments from foreign investors. When the crisis hit South Africa late in 2008 and during 2009, the policy response was to lower rates to improve liquidity in the local economy. But that had an adverse effect on the carry trade and it did not take long for the Rand to start a long period of decline from which it has not recovered significantly to this date.
Perhaps for the Bank of Namibia, the only option will be to leave rates unchanged, even for another semester, and first get a clearer indication from the US economy which way their rates are going.
If however, JP Morgan’s quarterly results come on the back of an improving US economy, then Mrs Yellen will want to resume her signalled increase of short term rates. The moment that happens, long term rates will respond, and then we are in trouble. The only option out will be to increase local short term rates but by doing so, we will shoot an already fragile economy in the foot.
This will not be an easy call to make, and given the dire straits from which we are only starting to recover, rates movements in the US may just make matters worse for us.
This is not a uniquely Namibian phenomenon, all emerging economies are exposed to the vagaries of developed markets where sentiment has the upper hand over fundamentals. Many analysts are saying the US bond market is in a bubble. This may be so or not, depending on whether you are a borrower (the US government) or a lender (institutional investment managers), but the most probable outcome is that first, US long term rates will rise and then short term rates.
We have absolutely no control over what happens in Washington, but here at home, we have to be extremely vigilant what impact an American policy response will have on the JSE, on the Rand, and eventually on our tentative economic recovery.