Good news for South Africa from the United States
The latest inflation print in the United States has brought some positive news for South Africa, with the rand, interest rates, and government bonds all possibly benefiting.
The US May Consumer Price Index was broadly in line with market expectations at 4.2% year-on-year, but softer at the core level than expected, standing at 2.9% year-on-year and 0.2% month-on-month.
Kristof Kruger, Head of Fixed Income Trading at Prescient Securities, said that a softer core print suggests that underlying inflationary pressures in the US are not broadening as aggressively as feared.
“Headline inflation remains elevated, but the latest move appears more closely linked to energy than to a broader demand-driven inflation impulse,” said Kruger.
“This is a better outcome for bonds than a hot core print would have been.” Core inflation excludes the effects of food and energy increases.
He added that the latest print does not remove the risk of further US Federal Reserve tightening, but it does make the case less straightforward.
Central banks around the world have been widely predicted to increase interest rates amid rising fuel prices. In South Africa, the Reserve Bank hiked interest rates by 25 basis points in May.
An interest rate differential between South Africa and the US often leads to rand appreciation, as investors chase higher returns in South Africa.
Higher rates in America thus hurt the local economy, as investors were rewarded with relatively high risk-free returns, with US Treasuries highly unlikely to default.
Ahead of the US CPI release, markets were digesting a stronger payrolls print and a more hawkish rate repricing.
“A stronger core CPI number would have reinforced that move by suggesting that labour-market strength and underlying inflation were both moving in the wrong direction. Instead, the data is more nuanced,” said Kruger.
“Headline inflation is still high, but core inflation was softer than expected. That creates a more complicated policy backdrop for the Fed.”
He said that if the inflation shock is mainly energy-led, further tightening risks could turn into a supply-side shock.
While the Fed could respond to second-round inflation effects, Kruger said it cannot solve an oil shock solely through higher rates. This makes it harder to predict the Fed’s hiking path.
Implications for South Africa
Kruger explained that the transmission runs through the main channels in South Africa: US Treasury yields, the exchange rate, local forward rate agreements (FRAs), and government bond curves.
He said that a softer US core print is helpful as it reduces the risk of a more aggressive Fed response.
This supports emerging-market carry, eases dollar pressure and gives South African bonds a better backdrop.
However, South Africans shouldn’t get too optimistic, as South African and American inflation are facing distinct issues.
In the US, a softer core print means that inflation may be more stable than expected. In South Africa, the market is still dealing with oil-sensitive inflation, exchange rates and the Reserve Bank’s inflation goal.
The Reserve Bank has a new 3% inflation target, and the latest inflation print stood at 4% in April. This is at the upper end of the SARB’s tolerance band. The impact on the US print locally has been limited.
“The US CPI print was bond-friendly, but local markets have not rallied cleanly,” said Kruger.
“The rand has not strengthened decisively, Brent remains above $90, FRAs are still sticky, and swaps have moved firmer.”
Looking ahead, oil price movements are central to the South African inflation outlook. Brent is below the recent spike but still high enough to affect fuel prices and inflation expectations.
Recent fuel-price over-recoveries could lead to relief at the pump in July, which would help the near-term inflation profile if oil and the rand remain stable.
“However, the reintroduction of the fuel levy reduces the size of the benefit, and renewed oil or rand pressure would quickly change the calculation.”
The bond market is also not treating inflation as fully anchored in South Africa. Breakevens, the difference between a nominal bond and an inflation-linked bond, have eased, but they are elevated.
The bond market is not yet treating South African inflation as fully anchored. Breakevens have eased from the recent spike, but they remain elevated and continue to price inflation above the SARB’s preferred 3% anchor.
The Reserve Bank Governor’s message about returning inflation to 3% supports long-term credibility.
However, in the near term, interest rate expectations will be sensitive, as the market knows the SARB is likely to respond if inflation expectations rise.
The softer US core print gives South Africa breathing room, but it does not remove local inflation or policy risk.
While the US print is good news for South African government bonds, it does not solve South Africa’s oil, rand and breakeven problems.
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