How Far Markets Forward Price

How Far Markets Forward Price

US and SA inflation rates have dropped substantially over the last few months, in a fortnight we are expecting interest rates to be cut, both locally and abroad.

Old Mutual’s chief economist Johann Els comments on the latest lower inflation data; 

“Interest rates: The relatively fast easing in headline inflation that I expect over the next few months could result in a 50bp (0,5%) rate cut at one of the two remaining MPC meetings this year.

While my forecast—for now—remains a 25bp (0,25%) rate cut at both the September and November meetings (given the Reserve Bank's conservative and hawkish stance), the decline in inflation may be more pronounced than the Bank’s forecasts. This could trigger a debate within the Reserve Bank about front-loading rate cuts.

My revised outlook on (US) Fed rate cuts could serve as an additional catalyst, possibly leading the Reserve Bank to cut rates by 75 basis points (0,75%) total during the remainder of this year. While my forecast does not yet reflect a faster cutting cycle, the risks have started shifting in that direction.”

Personal Inflation Versus Impact on Investment Markets

On personal inflation and interest rates falling, one must remember that interest rate cuts take several months to work through to the man-in-the-street. And even a 0,25% rate cut, both offshore and in SA, does very little in the very short term. But 1,25% to 1,5% over 6 months, and given a little time to work through, then does make a significant difference.

Investment markets on the other hand, and specifically the risk assets of share, bond and listed property markets, however, forward price themselves up to a year in advance, on the information available today. These markets benefit from lower inflation and interest rates, and therefore these markets are far quicker to react to changes in inflation. This is our interest on this side in keeping a close watchful eye here.

The first interest rate cuts are already fully priced into both local and share markets for later this month (0,25%, with an outside chance of 0,5%). These interest rate cuts are so “already in the price”.

Asset Class Returns Over One-Year

This shows when looking at asset class returns over the relatively short period of one year to the end of last month;

A good example of this is in SA, where the Listed Property Index has now gained 38% over one year to the end of August.

Even local Bonds have outperformed Offshore Equity – something that a year ago, in the prevalent negative sentiment in our country at that time, many would have thought was simply not possible.

To the end of last month, the Rand has strengthened by 5% to the US Dollar over the last year.

This is partly because of a weaker US Dollar resulting from US Inflation declining further over recent weeks, as one would expect where their inflation is lower. At the same time, it should also be noted that the rand has also neatly outperformed its emerging market peers over the past few months.

And all of this has been further supported by the optimism since the Government of National Unity (GNU) took office.

A stronger rand detracts from the returns South African investors earn abroad, but at the same time, it tends to benefit domestic interest-rate sensitive assets as is the case now. 

Coming off a low base a year ago when SA saw much negative sentiment, this good increase in the Bond and Listed Property markets, is the investment markets anticipating and taking into account that interest rates will be cut shortly, although we haven’t even seen these first interest-rate cuts yet.

This shows the extent of just how far markets forward price the risk assets on inflation and interest rate expectations.

Persevere – Staying the Course | Ninety One

Enjoying good market returns is a function of remaining patient through market cycles.

Ninety One shares this graphic highlight this importance, showing the impact where if one tries to time the market and gets it wrong, this can prove very expensive;

What interest rate cuts in South Africa will mean for the rand

BusinessTech also coming out with their thoughts on the rate cuts and rand here:

What interest rate cuts in South Africa will mean for the rand – BusinessTech

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Friday Food for Thought