Interest rates in SA to be Cut Shortly | The Alternatives in the Space of Cash and Cash Equivalents

Interest rates in SA to be Cut Shortly

Over the past few months, our own SA inflation has been drifting lower, and all of us can see this in our lower food and fuel prices, which are expected to drop even further next month.

For us in SA, we are due interest rate cuts, yet we have been waiting for the US to lower theirs first, as the risk is that if we are too early to do so, it could weaken the Rand, causing more inflation again.

Similarly, given the size of the US economy, many other countries worldwide have felt the same. Yet, delaying interest rate cuts too much can damage economies. So many other countries have recently come out believing that they cannot wait any longer, with the UK a fortnight ago seeing the Bank of England cutting their interest rate by 0,25% for the first time in over 5 years.      

Old Mutual’s chief economist Johann Els on Monday commented;

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

While my forecast – for now - remains a 25bp rate cut at both the September and November meetings (given the conservative and hawkish stance of the Reserve Bank), 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 Fed rate cuts could serve as an additional catalyst, possibly leading the Reserve Bank to cut rates by a total of 75 basis points 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”.

US CPI inflation This Week Lower in Line with Expectations

This week's latest US inflation data was largely in line with estimates, and marginally below consensus, up 0,2% month-on-month. Or 2,9% year-on-year vs 3,2% consensus expectation, confirming the inflation rate in the US is decreasing. Core US inflation (CPI less food and energy) came in at 3,2% in line with expectations;

Ninety One View on Interest Rate Cuts in SA

In turn, Ninety One released their forward view on interest rates in SA on Monday, that is largely in line with Old Mutual’s Johann Els too;

What Noise to Expect in Coming Months | “Possible US Recession”

Lower inflation and Interest rate cuts are good for markets, both locally and abroad.

Interest rates especially in the US and UK, have been very high for quite some time, and today they still remain at elevated levels.

Higher interest rates are designed to curb inflation, in slowing down the economy.

This is on the proviso though, that this is not overdone either, as economies can then be forced into recession.   

Therefore, this raises the question of recession possibilities, in either the US or UK, and thereafter in SA (?)  

According to Johann Els, “I do not believe that the US economy is heading toward a recession any time soon, but I do expect that the economy will experience substantially slower growth in the second half of 2024 and into 2025 compared to the robust growth during the first six months of this year.

My view is that the Fed will not cut rates between meetings (i.e. before the scheduled September meeting), as that would likely be seen as a ‘panic’ move. But I expect that the Fed will cut rates by 50 basis points in September, compared to previous expectations of 25 basis points. I expect a similar-sized rate cut in November, followed by 25 basis points in December. This would equal a total cut of 125 basis points for the remainder of the year.

In SA, available second-quarter economic data points to positive GDP growth, up from the -0.1% quarter-on-quarter decline in the first quarter. My initial forecast is a +0.4% growth for the second quarter. However, a substantial amount of data for June has not yet been released, and there are some sectors where high-frequency data is not available.

In addition to the likely positive growth for the April to June period, there is an increasing chance that first-quarter GDP growth data could be revised into positive territory. Revisions in mining and manufacturing production data have shown somewhat better growth in these sectors than previously reported”.

Planner Comment | “As Long as Recessions are Avoided, Lower Inflation and Interest rates are Good for Markets”

My comments here, is firstly, that “markets are gonna market”. Don't let periods of calm fool you, short-term volatility is a part of equity investing. If you take a longer-term view, however, you need to squint to see these episodes on a chart. Time is your friend.

Secondly, the big question remains whether the US economy has a soft landing or a hard landing. It is the latter that turns corrections into bear markets. I don't think there will be a hard landing, nor does our chief economist, but if there is, it won't be because financial conditions have tightened. They have eased.

Thirdly, interest rate cuts are coming. The US Fed may not necessarily ease as much as is priced in currently, but it remains a significant turning point. The global risk-free rate is about to fall, reducing pressure in all corners of the world.

Over the coming months, one can expect many press articles questioning a recession in the US as it slows. From our side, the US growing 3% in the 2^nd quarter this year, and expecting 1,4% in the 3^rd quarter - it’s an extremely long way from here, to get to negative (recessionary) growth.   

From our side “in the final analysis, as long as recessions are avoided which certainly appears intact, lower inflation and interest rates are good for markets”.

Lower US and SA inflation Gives Rise to a Stronger Rand

All other things being equal, lower SA inflation also means a stronger Rand.

If you think back in the past, whenever inflation and SA interest rates have been higher, then this has usually been accompanied by a stronger Rand, and vice versa.

Historically, lower inflation and interest rates mean a stronger Rand (and vice versa), and so yesterday we saw the Rand breaking through the R18 to the $US level again.  

Income Funds as a Cash Solution

Maintaining a healthy cash reserve remains a key financial planning pillar.   

Where money market rates are just under 9% per annum at present, this has been attractive after last year’s interest rate hikes, yet we can all see that the current interest rate is going to drift lower shortly.  

Therefore, where excess cash is held, the investor should be looking at more equity (share) exposures (both locally and abroad).

However, most investors including retired persons are not going to have a fully equity-based portfolio. That bit of cash that you always have access to funds in the form of a cash reserve, remains a key financial planning pillar.   

For investors who wish to keep some cash and cash equivalents for a certain part of their portfolio, Income Funds remain a good solid reputable option with a strong track record.  The minimum investment size is usually very low, and liquidity is simply a few days being the time to pay funds out.    

What Do Income Funds Invest In?

These invest in money market and deposit accounts, together with short-term bonds, where the overall duration is no longer than 2 years (meaning far lower risk than a bond fund).   

Reasonable Return Expectations from Income Funds

Investors looking at Income Funds as a solution, need to be prepared to take some short-term Income Fund volatility in seeking to achieve returns of 1% - 2% per annum more than the traditional money market over rolling periods.   

It is acknowledged that more value will be added in times of a decreasing interest rate cycle, than in an increasing one.

From the income fund specifically, in a soft increasing or flat interest rate cycle, an expectation for the outperformance of closer to 1% per annum over and above money market is realistic, and in a decreasing interest rate cycle this ought to be around 2% per annum. In the past, this has been up to 3% more, depending on how far interest rates fall.    

2023 Return from Income Funds

Last year the average money market return was 8,4% for the 2023 calendar year, where interest rates increased during the year.

Income Funds usually not do as well during interest rate hiking cycles, most of the Income Funds returned between 9,4-9,6% for the last calendar year.  These were very pleasing results in an interest-rate hiking cycle.  

More outperformance to traditional money market can be expected during interest rate decreasing cycles, by the longer duration in the shorter-term bond holdings.   

Recent Past Results from Income Funds

I summarise the results of the leading Income Funds to the end of July:

 *returns for the 3 years are annualised (per annum) returns.

BCI Income Plus Fund has the highest returns over 1 and 3 years, by it being a credit-only fund and having had good offshore credit spreads.

Each of these funds after June, gained over 1% for July.

Ninety One Diversified Income Fund Manager Video

Per this video link below, lead fund manager Malcolm Charles of the Ninety One Diversified Income Fund succinctly shares how his Fund has protected capital and achieved cash + inflation returns, despite local and geopolitical volatility.

Our latest Portfolio Manager insights | Ninety One | South Africa

In the interview, Malcolm confirms the yields on the assets held within the fund, is at 10,4% per annum.     

The fund manager view, that we agree with, is the expectation for these funds to deliver double-digit percentage returns for 2024 and 2025. The current yield of the fund’s assets so supports.  

Income Funds Are Not a Homogeneous Grouping

Importantly, Income Funds are not a homogenous grouping. Some Income Funds carry far more risk than others.

The Ninety One Income Fund for example is the most conservative. If you would like to see the fund fact sheets of these funds for the rounded view, please let me know.

For investors who like this option (within the space of cash and cash equivalents), but who do wish to see a greater risk/reward relationship, the duration in pure Bond Funds is considerably higher (longer), but still conservative enough for longer-term holdings, in Living Annuities as an example.

For the investor who wants cash and cash equivalents but is open to a longer intended timeframe to manage any potential short-term downside risk from the bond content - these are the leading options.

This week, Allan Gray who was previously always limited in this space, is launching two new funds to their fixed income offering – the Allan Gray Interest Fund and the Allan Gray Income Fund, which will be available for investment from 20 August 2024.

PWM Extra Interest Fund

In turn, at PWM we launched our own Income Fund offering in October last year, designed to be a more defensive and secure Income Fund, where the main characteristics are:

Over the past six months, we have neatly outperformed Money Market with a defensive Income Fund holding structure, that is our aim (to outperform Money Market with the least possible investment risk) with this fund.    

Past Performance Following Crises Events When Interest Rates are Cut

This graph independently prepared by Marriott, shows how short SA bond blow-outs traditionally have been, that usually only last a few months before subsiding again, with good investment results that then follow;   

 Of course, naturally, these extra high returns shouldn’t be seen as an expectation, but rather as the upside potential that does exist, where we have large events that are then followed by a cycle of interest rate cuts.

Prudential on SA Bonds | Are SA Bonds Still Attractive after the Recent Rally? 

After the good run from the bond market the past few months on our lower inflation data coming out in conjunction with our GNU following our election, and where most Income Funds have now returned over 10% the last year - the natural question is what is the prospects going forward from here?

Per the last attachment, the Mail and Guardian (previously called Prudential), share their views on why they remain bullish for local bonds;

“Equally, history suggests that the SA bond market typically delivered a return of around 13% p.a. over the next three years from a starting valuation such as this.

Even though it is possible for things to turn out very differently this time, judging by history alone, the valuation remains compelling”.

Sharing a rounded independent view from M&G which is much in line with our thoughts too, and where the Income Funds share in the Bond Market on the shorter side.

All these reputable solutions with solid track records are available via ourselves either directly, or on the leading investment platforms, for investors wanting some protection on their cash funds where interest rates are set to decline shorty.

Personal News from Jurie

I wanted to inform you that I will be on a soft leave from Monday, 9th September, until Friday, 27th September. During this time, I’ll be spending quality time with my family at our family farm in the Eastern Cape. As the area has limited signal and Wi-Fi, I won’t be able to conduct meetings, and my response time to emails may be slower than usual.

If there has been a change in your financial situation since our last conversation and you’d like to schedule a meeting, please reach out before the start of September so we can arrange a time before I leave.

While I will still be checking emails occasionally, please note that my availability will be limited. For any urgent matters, feel free to send me a WhatsApp message or call me directly. If you’re unable to reach me, you can contact our office at 021 555 9300.

For administrative queries, please reach out to:

Charlene Kemper at [email protected]

Angela Paterson at [email protected]

Natasha Jonker at [email protected]

For advice-related queries, you can contact:

Heinz Nel at [email protected]

Thank you for your understanding and for respecting this time I’m spending with my family. I appreciate your patience and look forward to connecting with you upon my return.

Friday Food for Thought