SA’s fall from grace sends it barrelling towards recession ahead of the much-anticipated US downturn

12 Mar 2023

All signs point to SA entering a technical recession in the first quarter – ahead of the US, where economic fortunes have turned around the prospects of a recession in the first half of this year and in contrast to South Africa’s fall from grace in the last few weeks.

The great thing about all the anticipation of recession this year in certain parts of the globe is that the variety of resources available to, hopefully, spot one coming has expanded considerably. But that doesn’t mean that they will all point in the right direction.

A negative yield curve has historically been considered the best harbinger of recession and, in the US, the yield curve has been inverted since July last year. Time will tell if it’s right, with past experience suggesting that recession follows a negative yield curve about a year to 18 months later. However, this indicator is increasingly becoming viewed as less useful and more reflective of market expectations regarding inflation and interest rates.

The Conference Board has a dedicated “indispensable” guide to Navigating the Economic Storm, in which it quantifies the probability of recession in the US, which is still close to 1 (highly likely). There’s also a Global Recession Map, which is of particular interest because it highlights how quickly the tables can turn. In a month, the US economy outlook changed from one of the Fed pivoting and perhaps reducing interest rates before the end of the year to a far more hawkish outlook. The jury is still out on whether the US will actually fall into recession. As the Wall Street Journal pointed out this week, it’s become the recession that is always six months away.

Sadly, for South Africa the same cannot be said. On the map, it is one of the countries that is not expected to fall into recession but, with bad news snowballing over the last couple of weeks, the prospect of a recession is ever more likely. From South Africa’s inevitable grey listing, growth figures that were way worse than expected, business confidence figures this week that showed just how dire the economy is considered to be by the private sector, the first current account deficit since 2019 and S&P Ratings downgrading South Africa’s credit rating outlook to stable from positive, it’s been a depressing few weeks for South Africans. It’s cold comfort that the rating agency didn’t shift the outlook down to negative, which is arguably more reflective of where we stand right now.

Thus, we can expect the Conference Board’s recession map to be updated because a recession in South Africa is all but assured. The only thing we don’t know is whether it will be a technical recession, namely two quarters of decline and then a turnaround, or whether it will descend into a more painful, prolonged recession. The global growth backdrop and the state of the country’s electricity crisis will be the deciding factors when we look back on 2023.

In the US, the National Bureau of Economic Research is the unofficial arbiter of recession and recessionary indicators it relies upon are not signally that the US economy is currently in a recession. JP Morgan captures the indicators that rose or fell over the last six months and the latest data show that real wholesale and retail trade and industrial production are the only ones that declined. Real personal income, Nonfarm payrolls, employment and real consumer spending are all in the green – and contributing to the difficulty the US Federal Reserve is having in bringing down inflation so that it can ease off on rate hikes and, hopefully, engineer a soft economic landing.

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Another interesting indicator is the Vanguard Leading Economic Indicator (VLEI), which infers developing economic trends by capturing shifts in housing, consumer, manufacturing, financial, expectation, price and interest rate trends and other variables. Vanguard senior US economist Josh Hirt describes the current state of the US economy, based on the VLEI, as “stuck in the messy middle.” He says: “Activity has weakened in the most interest rate-sensitive sectors of the economy. But core areas are still showing resilience. We are in this in-between period where the impact of rates has not fully worked through the economy.” Looking forward, more of the core indicators are expected to turn red and yellow as the impact of continued rate hikes take their toll on the economy.

With a US central bank still set on raising rates into the foreseeable future and perhaps even moving back to 50 basis point hikes, what does that mean for the beleaguered South African economy? Both Sanlam Investments economist Arthur Kamp and Old Mutual Multi Managers investment strategist Izak Odendaal expect the Reserve Bank to increase the repo rate by at least another 25 basis points. According to Kamp, most of the heavy lifting has been done by the Bank and we are close to the top of the interest rate hiking cycle. The risk to his base case is the possibility that the US Fed will implement a 50-basis point hike in March and if the rand remains weak and raises potential inflation.

On the host of negative domestic economic news that has emerged recently, Kamp says: “It is an unfortunate set of circumstances, since the economy already has dim growth prospects this year. Indeed, I think there is downside risk to already meagre growth forecasts for 2023. For now, this may limit the extent of future local interest rate hikes. But, future currency developments are now key.”

Odendaal says he thought January would be the last hike for the MPC but that if the Fed keeps up the pace of rate increases it will put tremendous pressure on all other central banks to keep pace, including the SA Reserve Bank. He adds that overall South African inflation pressures are moderate if you exclude food and fuel prices, but there has been some evidence of rand-sensitive items experiencing accelerating inflation. “The global backdrop is the big driver. South Africa has had a modest hiking cycle compared to our emerging market peer group. The country went from having some of the highest short-term rates in emerging markets to being towards the low end.” Thus he expects the SA Reserve Bank to hike the repo rate by 25 basis points later this month as “insurance”.

On the fast-weakening domestic growth outlook, Odendaal says the SA Reserve Bank has long argued that it is a supply-side problem, not a lack of demand, and that rolling blackouts etc lower the potential growth rate. “When potential growth is low, the ‘output gap’ between actual and potential growth is small, and therefore doesn’t require much monetary stimulus,” he adds.

Thus the Bank is unlikely to ease off the accelerator based on local economic considerations and should the resilience of the US economy continue to underpin inflation and justify further rate hikes, the declining domestic economy will get no reprieve from across the Atlantic.

That means that South Africa is far more likely to experience a recession before the US – a turnaround in a matter of months from what was expected late last year, and our depressing new reality unless there’s profound structural change and an end to rolling blackouts. BM/DM

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