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Sitting at the bottom of the interest rate cycle, potentially for much longer

The South African Reserve Bank’s Monetary Policy Committee (MPC) voted in May 2021 to again keep the repo rate unchanged at 3.5%, its lowest level since the series was introduced in 1998. Lower interest rates, although a life jacket for those in debt or with home loans, have naturally negative consequences for savers.

The MPC has been keen to impart that they want to keep financial conditions supportive of credit demand and loan growth. They highlight that low rates are their “contribution to the recovery” as South Africa emerges from lockdown and grapples with the economic costs of the pandemic. 

This is the fifth meeting in which the MPC voted for no change, and the second meeting in which the vote was unanimous for no change.  This unanimity really signifies their sentiment that we are now at the bottom of the interest rate cycle. Members who previously voted for further rate cuts are of the opinion that such action is no longer appropriate.

Why would their attitude have changed?

The one-word answer is “inflation”. Fears of inflation have been driving global and domestic fixed-income markets to extreme levels all year. US 30-year government bonds have fallen by 15% year to date as the market looks for the enormous US COVID-19-related stimulus spending to wreak havoc on consumer prices. After a multi-year slump in inflation to benign levels, investors earning a fixed rate are justifiably nervous should this situation finally change.

Locally, South African inflation took a swan-dive into the pandemic as global oil prices and local economic activity plunged. Our latest April 2021 inflation reading at 4.4% puts us at the narrowest gap to US inflation (of 4.2%) in 15 years.  The MPC is aware that there are upside risks to our inflation outlook via ongoing increases in oil and fuel prices, as well as global supply chain issues and imports. They must constantly weigh up such dynamics against offsetting disinflationary factors, such as those evident in the weaker housing market and a robust local crop production that may temper food prices.  The outcome of the public sector wage negotiations will also be a key input into the inflation equation.

While its own quarterly projection model suggested a rate hike for the current quarter, the Reserve Bank stood resolute in immovability.  They are committed to looking through temporary price shocks so that they can keep giving their gift of low rates to the economic recovery effort. 

What does this mean for money market investors?

It will still be a long time before money market funds enjoy the types of pre-COVID-19 rates of return of 7-8%. While the MPC’s Quarterly Projection Model proposes a repo rate above 6% by the end of 2023, this is merely a suggestion.

Against this backdrop, investors must continually re-evaluate their ability to take on risk if appropriate to their situation. There is no one size fits all. For the extremely risk averse, it may make sense to stay in a money market fund or in a fund with very low volatility. However, for real long-term growth, some exposure to riskier asset classes is essential.

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