Coffee table economics with Anchor

Anchor’s coffee table economics note by Casey Delport will be distributed intermittently and is a collection of Casey’s opinions on key economic factors and events shaping markets globally and in South Africa (SA). It is essentially Casey’s thoughts and perspectives on the multiple dynamics at play in the global and local economy.

Executive summary

In this week’s edition, we highlight the following: 

  • The US Federal Reserve (Fed): Have interest rate hikes entered their final season? The end of the Fed’s rate-hiking cycle may be approaching sooner than what was expected before the recent problems in the US banking sector emerged.
  • The plans by Israel’s Prime Minister Benjamin Netanyahu’s nationalist religious coalition to hand control over judicial appointments to the executive while giving parliament the power to overturn Supreme Court rulings has ignited one of the biggest internal crises in Israel’s history. There are, however, much bigger issues underlying the current crisis.
  • SA consumers are feeling the pinch – if we can afford the salt, that is: With higher inflation (particularly food prices) eroding households’ real wages, big interest rate increases lowering disposable income, extreme loadshedding, an increasingly tricky socio-political environment and generally uncertain future weighing on local consumers across the board, we hold a particularly subdued outlook for household consumption spending in 2023.
  • The Black Sea Grain Initiative: Russia stands to gain from the grain: While the magnanimous intention of this deal was to increase grain exports from Ukraine, Russia has also benefited from the initiative through increased wheat exports.

The US Fed: have interest rate hikes entered their final season?

Like your favourite (and probably, in your opinion, underrated) Netflix series, the US Fed’s interest rate hikes have seemingly entered their final season. The Fed raised its policy interest rate by 25 bps to a target range of 4.75%-5% on 23 March. The move was bang on expectations – financial markets had scaled back their expectations for no change through the week, so the 25-bp hike was the consensus forecast heading into this meeting. The Fed’s target range now stands at its highest level since 2007. Notably, in his post-meeting press conference, Fed Chair Jerome Powell said that the Fed had considered pausing its rate-hiking campaign as conditions in the banking sector remain volatile. Indeed, Powell emphasised how the impact of the current banking mini-crisis (see Anchor’s note entitled, The excess deposits banking mini-crisis, dated 16 March 2023) on the real economy is still unknown – no surprise there. While investors begin to pause, reflect and edit their seasonal scripts for the way forward, the Fed’s latest full monetary policy statement read “some additional policy firming may be appropriate” instead of the February statement, which noted, “ongoing increases in the target range will be appropriate”. Minor tweaks make a big difference in Fed statements, and this change is a sign that rate hikes could be winding down.

Furthermore, in the Q&A session following the Fed’s announcement, Powell commented that in the wake of the stresses in the banking sector, the Fed sees a high likelihood of a further tightening in US bank lending standards. As a result, stricter lending criteria will naturally slow the flow of credit. The US commercial property sector (which borrows heavily from smaller regional US banks) is particularly vulnerable to this type of slowdown in credit growth. Therefore, it is no real surprise that Powell’s comments fuelled renewed concerns about the outlook for US economic growth and led financial markets to aggressively price policy rate cuts by the Fed later in 2023 (despite the push-back from Powell himself). Whether these expectations are realistic or not, they pushed the US dollar weaker against the euro and drove a significant decline in US long-term interest rates.

The bottom line

This might signal that the end of the Fed’s rate-hiking cycle is approaching sooner than expected vs before the US banking sector problems emerged. So far, markets are pricing in another 25-bp hike at the Fed’s next policy meeting in May.

Israel’s judicial crisis: A country searching for its identity 

The plans by Netanyahu’s nationalist religious coalition to hand control over judicial appointments to the executive while giving parliament the power to overturn Supreme Court rulings has ignited one of the biggest internal crises in Israel’s history. Israelis have been staging mass protests for months against the hard-right coalition government’s plan to overhaul a judiciary that it claims has become too interventionist. Critics of the proposal (which gives the coalition government the final word over judicial appointments) state that it would weaken Israel’s checks and balances and erode its hard-won democratic system. Moreover, critics are aplenty – including Israel’s powerful military. The proposal prompted so much alarm in military circles that Defence Minister Yoav Gallant, a senior Netanyahu political party member, publicly called on the government to delay its overhaul. Netanyahu promptly fired him. The dismissal reignited large-scale protests and escalated a crisis now freezing much of the country’s economy.

At the end of the day, a political crisis is not good for business – even Israel’s business community has hit the streets in protest, as corporate elites warn that the proposed judicial reforms would severely damage the country’s economy – specifically its much acclaimed high-tech sector. Israel has largely prided itself as the “startup nation” thanks to its world-famous tech ecosystem that churns out so-called ‘unicorns’ – companies that reach a valuation of US$1bn without being listed on the stock market and are the dream of any tech startup. As such, many of Israel’s prominent business leaders (from major bank CEOs to startup founders) have argued that the government’s plans for the judiciary will weaken Israel’s legal institutions, potentially lead to a credit-rating downgrade, and thus dry up the foreign investment upon which these startups depend. An estimated 90% of the high-tech sector is funded by investors outside of Israel. In an about turn, Netanyahu stated this week that “to avoid civil war,” he would delay his plan to reform the judiciary until after it could be debated during the next parliamentary session in April. The decision comes after strikes and mass protests brought the country to a relative standstill. Following the announcement, Israel’s largest trade union leader said it would call off the general strike by its 800,000 members.

The bottom line

Coming at a time when Israel faces a prolonged security crisis in the occupied West Bank, and rising tensions with Iran, the dismissal of its defence minister has appeared to many Israelis as if their government had seemingly set aside the national interest. While opposition parties gave a cautious welcome to Netanyahu’s decision to suspend the overhaul to allow time to reach an agreement, many protesters remain mistrustful. Moreover, Netanyahu’s plans for a judicial overhaul are set to resume following the Passover (Pesach) holiday (which ends on 13 April). Therefore, this chapter in Israel’s history is far from closed. There are, however, much bigger issues underlying this crisis – Jewish Israelis are bitterly split over the role of religion and state, the dangerous fragility of checks on government power, and a total void of any political horizons for a shared future with Palestinians. Unfortunately, these issues are far from resolved, and citizens are only getting more aggrieved.

Put the salt back on the shelf: SA consumers are feeling the pinch

Locally, headline inflation rose slightly by 0.1-pp to 7.0% YoY in February, in an unfortunate upside surprise. Notably, core CPI inflation (which excludes the more volatile categories of energy and food costs and is thus more reflective of broad-based price pressures) jumped more markedly by 0.3-pp to 5.2% YoY. However, the rise in core inflation was mainly driven by health insurance costs, which have started to adjust higher after two years of unusually low increases (not that we really noticed). Therefore, we do not see the rise in core CPI as reflective of a broad-based underlying price pressure that will be sustained – so there is no need to panic yet in that regard. While upside risks remain, we expect this core CPI print of 5.2% to be the peak, and we forecast that from March 2023, headline CPI inflation will resume its broad easing trend. Nonetheless, the critical risk factor for this outlook remains food price inflation, which has increased consistently for most of the past year, reaching 13.6% YoY in February. These are the price pressures starting to hit local consumers’ pockets.

Many factors that have driven local food inflation over the past year are not unique to SA. These include high global agricultural commodity prices and increased energy costs, which influence the prices of inputs such as fuel fertiliser. While a number of these global factors are easing, as evidenced in the continued decline in the FAO’s Global Food Price Index ([FFPI], which in February declined for an eleventh consecutive month), the depreciation in SA’s exchange rate has offset much of the global decline. At the same time, persistently high levels of loadshedding added significant costs across the agriculture and food value chain. Notably, the sharp exchange rate depreciation has prevented much of the observed decline in world prices from transferring to SA. Looking ahead, naturally, any significant appreciation in the coming months would have the opposite effect – easing domestic prices for agricultural commodities. However, this effect could lessen if loadshedding is maintained at lower levels. Unfortunately, the consensus is that loadshedding will likely remain at relatively high levels for the foreseeable future, which will, in turn, be a critical factor in keeping local food prices higher for longer. For March 2023, the high base effects of March 2022 are likely to cause food inflation to moderate somewhat. Nonetheless, an increase in administered prices, such as electricity, due to be implemented in April 2023, could add further cost pressures that, in turn, are likely to keep food prices elevated over the coming months.

Overall, those uncomfortably high grocery bills are beginning to weigh on consumer wallets. The First National Bank/Bureau of Economic Research (FNB/BER) Consumer Confidence Index (CCI) slumped anew in 1Q23 to a print of -23, the third-lowest CCI reading on record (the lowest reading previously was in 1994) and indicative of extreme concern among consumers about SA’s economic prospects and household finances. The CCI combines the results of three questions posed to adults living in predominantly urban areas of SA: 1) the expected performance of the economy, 2) the expected financial position of households, and 3) the rating of the appropriateness of the present time to buy durable goods, such as furniture, appliances and electronic equipment. Theoretically, the FNB/BER CCI can vary between –100 and 100, but the index has fluctuated between –33 (indicating an extreme lack of confidence) and +23 (indicating extreme confidence) since the BER started measuring consumer confidence comprehensively in 1982. The index’s average is +2 and could therefore be considered neutral. Thus, this latest print of -23 is quite concerning.

As has been the case for a long time, consumers are much more pessimistic about the economy than their personal finances. Still, the gap is particularly large now that the sentiment about the economy has fallen so steeply – unsurprisingly, thanks largely to Eskom. What is unusual, though, is that high-income consumers are now materially more pessimistic than middle- and low-income consumers – which has historically been the case in SA. This supports our view that household consumption spending will remain constrained in 2023. Moreover, with an increasing number of high-income households now investing (at considerable cost) in solar power and other backup power systems (again, thanks for that, Eskom), these households will likely, need to slash their discretionary spending to balance their budgets. As a result, sales volumes of big-ticket durable goods such as new vehicles, furniture and household appliances will likely face increased pressure in the coming months. However, in a somewhat ironic twist, replacement purchases of electronic goods due to loadshedding-related breakdowns should counter some of the adverse impacts. Unfortunately for the retail sector, it appears to be a case of wrong place, wrong time. With some upward recovery momentum still boosting the services sector (e.g., hotels, restaurants, transport, recreation and tourism-related services), the retail industry will likely bear the brunt of the collapse in consumer confidence.

The bottom line

The BER also noted that the significant drop in the CCI mirrors a considerable deterioration in retailer confidence, as uncovered by the 1Q23 Business Confidence Index survey – from 42 to 34 and its weakest print since the lockdown quarter of 2Q20. With higher inflation (particularly food prices) eroding households’ real wages, big interest rate increases lowering disposable income, extreme loadshedding, an increasingly tricky socio-political environment and a generally uncertain future weighing on SA consumers across the board, it is fairly safe to assume that they will not be engaging much discretionary spending over 2023. As such, we hold a particularly subdued outlook for household consumption spending in 2023. Local consumers are indeed feeling the pinch – if we can afford the salt, that is.

Black Sea Grain Initiative: Russia stands to gain from the grain

In an encouraging development for global food inflation, the Initiative on the Safe Transportation of Grain and Foodstuffs from Ukrainian ports, also known as the Black Sea Grain Initiative, has been extended for another 120 days and will be reviewed again after this period. This initiative started in July 2022 and is an agreement between Russia and Ukraine made with Türkiye and the United Nations (UN) to allow grain movement from Ukraine to world markets without Ukraine being attacked by the Russian military. Since the deal was first signed into fruition, Ukraine has exported about 25mn tonnes of grains and vegetable oils – one of the primary drivers for the decline in global food prices over the past 11 months.

While the good-natured intention of the deal was to increase grain exports from Ukraine, Russia has arguably also benefited from it through increased wheat exports. Russia typically exports about 35mn tonnes of wheat p.a., with its largest markets including Türkiye, Egypt, Azerbaijan, Kazakhstan, Nigeria, Bangladesh, Sudan, Latvia, Saudi Arabia, Yemen, Cameroon and Israel. In the country’s usual perusal of self-interest, Russia had a powerful incentive to continue with the Black Sea Grain Initiative as it had about 44mn tonnes of wheat for export in the 2022/2023 marketing year – up 34% YoY. This is according to data from the International Grains Council (IGC), whose preliminary projections for the 2023/2024 marketing year suggest Russia will again have ample supply due to strong production. Exports are forecast at 42mn tonnes. Whilst the Black Sea Grain Initiative was initially created with the best intentions to assist Ukraine, for Russia’s sake, it is important that the agreement remains in place for these grain exports to continue to flow from Russia with minimal interruption. Ukraine remains a critical player in the global wheat market, although its production has declined significantly due to the war. Despite the sharp decline in Ukraine’s wheat exports, the latest ICG forecast for 2022/2023 global wheat exports is at 199mn tonnes – up 1% from the previous season. In addition, Australia, Canada, the EU, Kazakhstan and Russia are expected to boost available supplies for the world market.

The bottom line

This improvement in export supplies means global wheat prices could continue to moderate over the medium term. Nonetheless, the geopolitical tone and war remain significant risks to the global grain and vegetable oil market for the foreseeable future. Therefore, extending the grain deal is a welcome development for countries across the globe, but the period is relatively short. A longer time frame is far preferable for market players to clear any uncertainty surrounding shipments for more prolonged periods. Nonetheless, as global wheat prices continue to soften, the deal extension benefits all wheat- and vegetable-importing countries (particularly SA).

 

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