Thematic view: The year so far

At the beginning of the year, we highlighted several trends to watch in 2024. With the midpoint of the year upon us, we review how these trends have shaped 2024 so far.

To recap, we saw some risks to US economic growth this year as a function of a weaker consumer outlook, elevated federal government debt levels, some scope for more depressed investment levels and some currency dynamics, which could impact net exports.

Further reasons for a weak consumer outlook were linked to the elevated level of interest rates in the US, and we questioned whether inflation had abated (which was the broad expectation).

We investigated the relative implications of the elections in the US, phrasing the question: “Is the Don making a comeback?” We noted that the two contenders for the US Presidency had vastly different policy agendas that could pose several fiscal risks.

From a South Africa perspective, we highlighted the significance of the local elections, which, coupled with depressed valuations, may have offered some opportunities. We were of the view that the structural reform programme being implemented by President Cyril Ramaphosa would play a catalytic role in enabling growth.

The war in the Middle East took us further into global geopolitical fragmentation as the Eastern Europe conflict continued. The war in the Middle East was potentially an upside risk to inflation globally given the area’s importance for supply chains and the oil trade.

Another of the themes was the resurgence of China, which hasn’t quite played out. This theme is not covered in this piece as we continue to monitor the evolving data. It’s worth mentioning however that risks to growth in China will have spillover effects for the rest of the world, particular commodity exporters like South Africa. 

1. The US economy

The US economy managed to evade a recession in 2023 despite elevated interest rates. The start to 2024 has been relatively robust considering how restrictive monetary policy in the US remains (the most restrictive since 2008/2009, see chart 1). We continue to signal some risks for some economic deterioration in the US. Our last few thematic pieces dealt specifically with the various components of GDP including consumption, investment, government expenditure and net exports.

Chart 1: Monetary policy restrictiveness in the US

It’s worth highlighting that the market got forecasts for first quarter growth completely wrong. The chart below illustrates that the Atlanta Fed GDPNow estimate at the time suggested that the US would grow at around 2.5% whilst the market was looking for around 2.1%.

The number surprised materially to the downside, with the preliminary estimate coming out at 1.6% and the second estimate coming out at 1.3%.

We see downside risks to GDP growth in the second quarter for a couple of reasons.

The US debt-to-GDP ratio (chart 2) remains elevated, which implies that the US government will find it incrementally more difficult to rescue the economy in the event of economic deterioration.

Chart 2: US debt-to-GDP

And US federal expenditure on interest payments as a percentage of GDP is at its highest level since the early nineties (chart 3). The outlook, based on Congressional Budget Office estimates, is for interest payments as a percentage of GDP to grow over the next 10 years. This implies that the interest payments are set to crowd out expenditure on other items in the federal budget.

Chart 3: US interest payments as a percentage of GDP

The US federal government has also been stimulating at a time when the unemployment rate has been low. Stimulus is usually only required at these kinds of levels when the unemployment rate is 6% or higher (chart 4).

Chart 4: US federal deficit and the unemployment rate

The key point is that the federal government will find it difficult to rescue the US economy.

There are several signs that the economy is deteriorating, but we will look at only three.

Delinquencies are rising, though they not yet at recessionary levels.

Consumption, which makes up around 70% of US economic activity is falling, albeit at a slow pace.

But the key risk to consumer health we believe lies in chart 5 below, which looks at excess labour demand in the US, we foresee significant risks to employment. The recent relatively robust economic activity has been a function of a labour demand-supply mismatch which is unwinding. When there is a shortage of labour, then labour become wage-setters and can demand higher wages which drive consumption. Once that situation unwinds, and employers become wage-setters, then lower wages would typically lead to lower consumption, which then impacts the profitability of firms and leads to job losses.

Chart 5: US labour force demand and supply

It is worth mentioning that job openings have been falling rapidly while job quits have also been slowing, indicative of a tightening labour market.

2. Inflation

Amongst developed markets (DMs), the US and Europe have faced differing economic environments that have influenced how inflation would influence monetary policy.

Europe, as mentioned in January, faced far harsher consequences following the Eastern Europe conflict and its implications for energy security. Europe, being highly exposed to Russian energy, felt the brunt of soaring energy prices. Coupled with supply chain issues, this resulted in the European Central Bank (ECB) hiking rates aggressively (like the US Federal Reserve) followed by the broader European economy slowing significantly.

This may be why the ECB was able to cut interest rates a few weeks ago, ahead of the US Fed. A broad economic slowdown was underway, while inflation continued to trend towards 2% but had not yet reached the central bank target. Inflation expectations are broadly lower in Europe, while wage growth has also trended downwards. Another possible reason for the cut was that producer prices, a leading indicator of consumer prices, had been in deflation for some time in Europe. Inflationary pressures have largely abated, and the next move by the ECB will be influenced by future inflation trends.

The opposite is true for the US. The US has not yet experienced a broad-based economic slowdown of similar magnitude to Europe. The US was also not as vulnerable as the EU to energy prices given its fuel reserves. Supply chain constraints contributed towards inflation in the US but those have largely dissipated.  Nevertheless, we continue to see some risks to this trend given the geopolitical issues in the Middle East and the climate-related issues in the Panama Canal.

Monetary policy appears to be overly restrictive in the US, and the labour force will be the key driver of economic activity and any potential slowdown. Restrictive monetary policy should lead to some economic deterioration at some point, as we monitor decreasing consumer expenditure, increasing debt service costs as a percentage of disposable income, a “twitchy” labour market and rising delinquencies.

In emerging markets (EMs), inflation is mostly under control. Among the group of EMs we track, inflation is broadly within central bank target ranges.

3. The US election – it’s neck-and-neck right now

There are a couple of ways to look at the US election and how each of the Republican and Democratic Party nominees are faring against each other ahead of the election, namely by looking at polls or looking at the betting market.

The polls and the betting market are telling us two different things now, but it is worth mentioning that it is in the betting market that people have something (monetary) to lose.

Chart 6: Betting market US election winner probability

Chart 7: US election IPSOS poll (Source: IPSOS, 25 June 2024)

The key issue when dealing with the outcome of the US election is its implications for policy stability. For example, we would expect Donald Trump to continue to run an expansive fiscal policy irrespective of the debt problem we indicated in the previous section. Trump’s perspective is that you can grow your debt away. President Joe Biden has already indicated that he would run a much tighter fiscal ship and even allow the Trump tax cuts to expire when the time comes.

4. Global elections are full in swing

As we started the year, we highlighted that around half of the world’s population would be voting in one form or another during the year, with some of the most significant elections having already taken place in the likes of the European Union, Russia, India, South Africa, Mexico, Taiwan, South Korea, Pakistan, Iran, Indonesia, amongst others. Out of 73 national elections for the year, a total of 35 have been completed.

The implications of so many elections lie in what they mean for the geopolitical alignment across the globe as well as for policy certainty and stability, depending on how the different countries vote.

Some notable election outcomes:

• Results of elections in the EU reverberated through Europe with far-right parties making big gains. This was most harshly felt in France where President Emmanuel Macron called a snap election. Germany suffered a similar scare after the far-right.
• In India, the Bharatiya Janata Party (BJP) lost its parliamentary majority for the first time under Prime Minister Narendra Modi, ushering in coalition politics in India.
• The same happened in South Africa.  The ruling ANC also lost the parliamentary majority it had held for 30 years, introducing an era of coalition politics at a national government level.
• Taiwan elected a western-aligned leader at a time of increasing tension in the South China Sea.
• Elections in Russia and Pakistan turned out as expected.
• Although Iran was holding legislative elections this year, but the death of President Ebrahim Raisi in May has resulted in Iran having to hold a Presidential election that is currently underway.

5. South Africa’s election – the story so far

Ahead of South Africa’s election, the electorate was faced with far ranging policy positions presented in the manifestos of political parties. It was in this vein that we identified four core pillars of the election which would have significant implications for South Africa’s economic trajectory.

The four pillars were as follows:

• Constitutional democracy
• Institutional independence
• Property rights
• Economic/structural reform

These pillars would have extensive implications for the economic foundations of the country, given that at least three of the pillars are constitutionally protected and that a changing political environment could impact the overall “rule of law”.

At the time of writing, negotiations are ongoing between partners to the Government of National Unity (GNU) following the election and swearing-in of President Cyril Ramaphosa. The partners to the GNU have shown a commitment to maintaining the Constitution and the rule of law and a continuation of President Cyril Ramaphosa’s structural reform programme (broadly supported within their individual manifesto documents).

The formation of cabinet and the strength of the coalition agreement between the relevant parties will set the tone on the trajectory South Africa will take. It is our view that the collective at the core should be committed to enabling economic growth, continuing with the structural reform programme, increasing business confidence, creating jobs, ensuring service delivery, and creating a better life for all. At the margin, it appears that the parties agree with that.

This would be positive for SA assets in general. We saw the rand plummet when the election results showed ANC support at 40% which incrementally increased the risk of a far-right leaning government formation. Since the announcement of the GNU, the rand has rallied, and inflation forecasts are set to reset lower. This would enable the South African Reserve Bank (SARB) to cut interest rates sooner than previously projected and before the US Federal Reserve. This should stimulate consumption broadly and be good for 'SA Inc' companies. More robust economic activity will similarly lead to higher tax collection by the state which can be used to service/lower debt (as was done with the Gold and Foreign Exchange Contingency Reserve Account (GFECRA)) and expand the delivery of services.

I’ve expressed these views in both the Business Day and Daily Maverick. As the politicians continue to negotiate, we hope that they rise to the occasion as South Africa’s future is at stake.

Link 1: Business Day
Link 2: Daily Maverick

6. Geopolitical fragmentation

One risk that arises out of geopolitical fragmentation is the risk to the overall direction of inflation globally. The Middle East is home to some of the world’s most important trade corridors as well as a major hub for the global oil trade. We thus could face two inflationary headwinds in the form of Brent crude prices and container costs.

Chart 8 below tracks the relationship between the Brent crude price and conflict in the Middle East. What is clear is that conflict in the Middle East is not the driver of pricing. The impact of conflict on the price of Brent crude is typically because of spillover effects of the conflict on the trading of oil (supply chains, price shocks, supply shortages, etc). At the time of writing, the overall impact of the conflict in the Middle East on the price of Brent crude has been relatively benign.

Chart 8: Relationship between conflict in the Middle East and Brent crude

What has been picked up by the International Monetary Fund (IMF) is the extensive localised consequences of conflict in the Middle East and Central Asian economies. The rest of the world tends to feel the impact on GDP-per-capita most harshly within the first two-years of the conflict. This is presumably related to, among other things, shocks to the energy sector and global supply chains that negatively impact inflation. As we have seen, these factors tend to filter out of the base as energy prices and supply chains normalise. The IMF’s findings suggest that the full effects of the Middle East conflict will be felt over the next 10 years and bodes negatively for economic growth in the area as well as the quality of life for those living there.

Chart 9: scars of conflict (Source: IMF, 12 June 2024)

7. Rising tide of protectionism

One thing was clear when global economies were reopening following the Covid-19 pandemic, was that most sought to be cushioned from the extensive consequences of broad-based closure of global trade that left many economies vulnerable to supply-demand mismatches for goods and services and the relative implications for pricing. It was also clear that some countries wanted to move away from a reliance on China in the light of the zero-Covid policy and closure of cities adopted by China.

While that was immediate and most clearly pronounced, we highlighted in January that this was not new. Trade policies implemented by Trump during his presidency highlighted his view on “America first” protection of jobs and industry in the US, etc. That has not materially changed during the Biden administration, and the most recent of example is the protectionist policies coming from US in terms of the electric vehicle industry. The European Union has followed suite in this regard implementing policies against Chinese electric vehicles.

The number of companies on the S&P 500 who mention the terms “nearshoring”, “onshoring” and “reshoring” has not abated. We saw a modest uptick at the end of 2023 and the latest earnings calls suggest that this is still a prominent theme within the minds of S&P 500 CEOs.

Chart 10: Protectionism trends on earnings call (Source: Bloomberg, 11 June 2024)

The number of new trade protectionist policies across the global are trending towards the record reached in 2023 according to Global Trade Alert, bearing in mind that we are only half-way through the year.

Chart 11: Rising tide of protectionism (Source: Bloomberg, 12 June 2024)

This trend should persist if “the Don” makes a comeback on 5 November.

We have also taken note that the trend in mentions of “nearshoring”, “onshoring” and “reshoring” is particularly pronounced in labour-intensive industries (chart 12).

Chart 12: Industries mentioning protectionism on the S&P 500 (Source: Bloomberg, 11 June 2024)

In closing, many dynamics remain at play and the state of the global economy remains uncertain. Growth rates in developed markets have diverged, as have interest rate dynamics. Inflation continues to present some near-term risks particularly as a function of supply chain issues and energy prices, but the aggregate expectation is for inflation, particularly in developed markets, to be further contained. Elections remain a source of uncertainty given the overall implications on the policy positions of countries and their geopolitical alignments, particularly important at a time when geopolitical fragmentation continues to rear its ugly head.

We are optimistic about the outlook for South Africa. The election results and the subsequent formation of the GNU remains fluid but at the very least, the partners to the GNU represent market-friendly interests, which should be good for South Africa’s economic trajectory. A further catalyst can be found in the President’s ongoing structural reform programme and strides made in improving operational performance at Eskom and Transnet.

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