Lourens Pretorius, Fixed Income Portfolio Manager at Matrix Fund Managers

The South African Reserve Bank (SARB), along with the US Federal Open Markets Committee (FOMC), is about to embark on a rate-cut cycle commencing this week. Not all rate-cut cycles look the same, however, and we would caution to expect the SARB to follow the FOMC step-by-step.

The US policy rate, currently at 5.33% is priced to be reduced by 40 basis point (bps) (or 80% of a 50 bps cut) on Wednesday and a cumulative 250 bps of cuts to 2.80% in December 2025. After a particularly dovish message delivered by Federal Chair Jerome Powell at the Jackson Hole conference in August, the market moved the debate from when cuts would begin, to how large and how deep they would be. The US Federal Reserve (Fed) pursues a dual monetary policy objective (inflation and employment) and at this juncture appears to be uncomfortable with labour markets slowing down faster than expected whilst headline inflation (and upside risks to inflation) are diminished.

We should note that our assessment of neutral real rates in the US is approximately 100 bps with inflation expected to stabilise at or about 2.0%, rendering the current cumulative rate cuts priced in the US marginally excessive. The pricing, however, is sensible if one considers that monetary authorities hardly ever cut from restrictive territory, such as the current setting, to a perfect neutral setting, but rather typically amplify the cycles in response to some slowdown evident at the time. In our opinion, it is perfectly plausible for the Fed to signal 100 bps of cuts in 2024 whether this starts with a jumbo 50 bps or alternatively signalling of more imminent aggressive cuts within the remainder of this year. The Fed does not like to surprise financial markets but it is uncertain what would be a surprise currently (50 bps or 25 bps)?

SA rates heading south …

Back to the South African Reserve Bank. Inflation, and maybe more importantly, forward inflation expectations have been moderating over the last three months due to a combination of lower fuel, food and administered prices and a firmer rand. It is quite conceivable that South Africa will experience annual price increases of less than 4.0% in Q4 of 2024. More importantly, sustained inflation outcomes closer to the current midpoint of the target of 4.5% appear to be achievable throughout 2025.

The South African neutral real rate is somewhere between 2.5% and 2.75%, which would mean a policy setting of 7.0%–7.25% (or a cumulative 100–125 bps cumulative cutting cycle) is achievable considering forward inflation expectations of 4.5%. Whilst there is no doubt that there is room and certainly a need for local interest rate relief, we do not expect the SARB to be influenced into larger local cuts by larger US interest rate cuts. We would be surprised to see a larger cut than 25 bps by the SARB especially taking account of the quantum of cumulative cuts available to them.

To add to this, the SARB has on many occasions expressed its desire to align South Africa’s inflation and targeted inflation to our peer economies. There are multiple associated benefits to lower long-run inflation, amongst these, a stable and competitive currency. To this extent, it is quite plausible that the SARB may view the current slowdown in local and global inflation as an ideal opportunity to re-anchor longer-term inflation expectations at more permanently lower levels. This would imply some short-term pain for longer-term gain with the SARB possibly electing moderately tighter short-term monetary policy in favour of significantly lower rates if successful with re-anchoring long-term inflation expectations.

… but a prudent approach to support rand

A prudent and somewhat conservative approach such as above by the SARB will continue to support the rand and bond pricing in as far as the SARB’s commitment to lower and stable inflation will become even more evident. It is not clear that there is any long-term trade off or sacrifice between growth and inflation, hence taking it slow for now will likely be the most appropriate response.

ENDS