Major US threat to South Africa’s economy
A probable US recession in 2024 spells bad news for South Africa’s already struggling economy.
According to RMB’s Chief Economist and Head of Research, Isaah Mhlanga, global asset classes had negative returns in August due to the rise in long-term US bond yields.
The US 10-year bond yield grew to 4.8% last week – the highest level since June 2007 – whilst the 30-year bond yield rose to 4.7% last month, with a further 27 basis points increase this October.
The shorter-date bond yields also grew to 5.0% in September, with a further 14 basis points in October.
“Historically, moves of this magnitude are significant and usually cause reallocation of capital across asset classes,” Mhlanga said.
In July, Mhalanga said US yield curves could be helpful for tracking US recessions.
“The gist of the conclusion then was that the US yield curve inversion — long-term bond yields being lower than short-term bond yields — signals a higher risk of a US recession in the months ahead,” he said.
“However, given the strength of the US economy and positive equity markets performance (even though based on a narrow technology sector) at the time, I received pushback on the US recession assumption.”
“There are still disagreements on this assumption, but the recent performance of bond markets is tilting the market view to a 2024 US recession. A mild recession is still the basic assumption underlying our macro views. Effectively, a US recession has been postponed rather than avoided.”
He said that there are several reasons for this, including loose fiscal policy while monetary policy is tightened, high excess household savings from COVID-19 pandemic cash transfers and strong labour markets.
The figure below shows the reduction in the extent of the yield curve inversion due to recent moves in bond yields, which has led to questions over the possibility of a recession:
He added that short-term bond yields reflect recent monetary policy decisions, whilst longer-term yields look to long-term economic growth and impact on fiscal policy.
“The rise in 2-year bond yields reflects the US monetary policy stance that has been guided for higher for longer policy rates due to sticky inflation and still strong labour markets,” the economist said.
“On the other hand, rising long-term bond yields reflect concerns and uncertainty about US fiscal
policy.”
A US government shutdown was only narrowly avoided last week, with a deal needed to be struck by 17 November to avoid a shutdown.
Moreover, Fitch downgraded the US long-term foreign-currency issuer default rating from AAA to AA+ due to fiscal degeneration, rising fiscal deficits and the country’s debt ratio.
The economist added that it would be optimistic to expect the US to avoid a recession next year as 30-year bond yields are nearly 5%.
He added that the reduction in the extent of the yield curve inversion does not mean that the chance of a US recession is declining, as it actually means the opposite when looking at historical trends.
“The US yield curve has historically been the most inverted at least three to nine months before a recession hits, which puts the relative timing for the next recession from now out to June next year,” he said.
“While it is difficult to tell, as we have observed since the inversion of the US yield curve on 5 July 2022, it is plausible to believe that markets and the economy rhyme with history unless there are clear propagating factors to believe that this time is different, which is usually not the case.”
South African pain
US recessions usually cause strong US dollar and capital outflows from emerging markets, resulting in emerging market bonds and equities outflows, weaker exchange rates and slower global economic growth.
Riskier assets will see pressure over the next year unless positive catalysts emerge, like an end to the Russia-Ukraine war and a signal to cut rates from the US Fed. However, the former looks unlikely due to the conflict between Israel and Palestine that started this week.
South Africa is a relatively small open economy which follows global trends in markets, with the rise in US bond yields already impacting South African assets – the rand is not 13% weaker compared to the dollar since the dollar due to this.
The JSE All Share Index has only returned 2.19%, whilst non-resident investors have taken R11.7 billion out of the country.
The All Bond Index (ALBI) has only returned to 1.47%, and non-resident investors have taken R44.6 billion from South African bonds.
“A further rise in US bond yields will only extend this poor performance as investors are likely to shift more into US bonds as they anticipate that a US recession is more likely and bond yields will soon fall,” Mhalanga said.
“Global asset allocation is underweight risky assets, global equities overall, emerging market equities, and high-yield credit. The fiscal challenges in emerging and developing markets, particularly in Africa, have also made hard currency debt in these countries relatively unattractive.”
“A further rise in US bond yields, a US recession and a strong dollar will extend this unattractiveness further.”
South Africa already faces several challenges from a macroeconomic standpoint, and a further slowdown in US and global growth will exacerbate the fiscal outlook.
GDP growth will remain restrained, negatively impacting employment creation and consumer finances.
The economist said deep and intensive internal reforms will be needed to minimise these challenges.
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