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The US Dollar is still overvalued
Since October last year the US Dollar Index (“DXY”) has fallen 5.6%. Despite this, it remains 5.9% higher than it was prior to the pandemic, and 26% above its 2014 levels. The DXY is trading 18% above its Purchasing Power Parity (“PPP”) implied level, which has typically been a reliable guide of the long-term returns of the currency. Given its relative strength and heightened valuation we believe it will weaken over the coming years, with only a short period of reprieve granted by the 2024 recession. While the USD typically moves inversely to global growth, the USD’s performance during the 2024 recession will depend on how severe the economic downturn is. If it is mild, as we expect, then the USD may not experience material upside as the Fed has substantial scope to cut rates, potentially more so than other central banks. However, if the recession is severe the USD will strengthen as capital flows into safe-haven assets, such as US Treasuries. This would be a similar event to what occurred during the 2008 financial crisis.
Source: Nedbank CIB Markets Research
Multivest Chartbook - April 2023
Source: Multivest Research
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Slowing growth, geopolitical fragmentation and future growth!
Decelerating world economic growth are increasing. So does geopolitical fragmentation and polarisation. This may delay a meaningful economic recovery. However, Asia may be the exception as it seems to be the region to outperform sooner. South Africa, though, will as usual, share in the downside of the world economic downturn, but less in the upturn. In the meantime, the mini banking crisis continued to cause volatility in financial markets.
The US economy weakened in Q1 2023 as the first estimate of quarter-on-quarter economic growth indicated a sharp deceleration to 1.1% compared to 2.6% in Q4 2022. The deceleration was driven by a more negative contribution from inventories while business investment and consumption’s positive contributions were less than expected. Growth for Q2 2023 may well be negative as the lagging effects of increasing interest rates kick-in. However, one more rate increase of 25 basis points in May should be the final one, given the consumer price inflation (CPI) trend. CPI is slowing fast as it was up 5% in March, much lower than the peak of 9.1% in June 2022. However, core CPI was still at 5.6%, slightly higher than in February, mainly on account of rising house prices. However, this is expected to decelerate as rising interest rates will reduce housing demand and limit house price growth. Rising interest rates (and poor management) had already contributed to a mini banking crisis in the US as a few regional banks had to be rescued – and the effects were still felt in April when the financial statements of other regional banks showed large borrowing from the Federal Reserve (following deposit withdrawals by the public). This contributed to financial markets remaining somewhat volatile in April.
In the Euro Area the economy grew by 0.1% in Q1 2023, just higher than the 0% growth of Q4 2022. CPI for March was confirmed at 6.9%, much lower than October 2022's high of 10.6%. Still, core CPI hit a fresh record high of 5.7%, making more rate increases unavoidable. Euroland is at risk due to its dependence on China and Russia, and therefore from geopolitical fragmentation. Christine Lagarde, president of the European Central Bank (ECB) said the current high CPI will be difficult to suppress in an environment of economic fragmentation - “… if global value chains fragment along geopolitical lines, the increase in the global level of consumer prices could range between 5% in the short run and roughly 1% per cent in the long run.”
However, given weak growth in the US and Euroland, Asia is where future growth lies. Central banks in the region have not raised interest rates into restrictive territory, meaning that the sacrifice in domestic demand should be much smaller than in the US and Euro Area. Also, three of Asia’s largest economies, India, Japan and China, are driven by domestic demand, which is supported by less restrictive monetary policies. And the expectation is for some Asian central banks to be of the first to start cutting interest rates.
South Africa, however, is a totally different kettle of fish. Policy makers are contradicting themselves frequently (the most recent the withdrawal from International Criminal Court just to turn around reconfirming its membership). The same holds for economic policy. There is still no consensus on how the energy crisis will be resolved due to conflicting views, making economic growth difficult to attain, while keeping interest rates high. In the meantime, CPI accelerated again in March to 7.1% despite hefty rate increases. Food prices remain stubbornly high, mostly due to purchasers who are locked into future contracts (with high prices). Food CPI should recede once the contracts come to an end in Q3 2023. As such, interest rates may only be reduced in Q2 2024.
Multivest Economic Division
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