Election’24: SA investors rightly fear a populist turn – John Authers

In South Africa, the ANC faces its toughest election in 30 years, possibly needing a left-wing coalition. Investors fret over fiscal consequences. Meanwhile, fund managers bet on reflation despite US voter scepticism. Bond markets stall awaiting April’s US CPI. And, David Byrne of Talking Heads turns 72, offering musical solace.

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By John Authers

Today’s Points

History Beckons in South Africa

South Africa’s African National Congress (ANC), the political party that Nelson Mandela rode to power and ended the apartheid regime 30 years ago, is on the brink of an unwanted history. Opinion polls ahead of the May 29 elections predict the ANC will likely fall short of the 50% needed to form a government by itself. It’s a dramatic fall from grace for the party, led by current President Cyril Ramaphosa, which got almost 70% of votes in the 2004 elections. Now, if the polls are right, it will have to turn to smaller parties to form a coalition government, for the first time since the end of apartheid.

The prospect of a coalition government is unsettling in one of Africa’s largest economies, where left-wing political parties are capitalizing on resentment over unfulfilled promises by the ruling party. One such party is the Economic Freedom Fighters or EFF, led by far-left politician Julius Malema, once a critical figure in the ANC, whose policies include nationalizing banks, mines and telecom companies. Capital Economics argues that while such radical policies may not come to fruition, such a coalition would carry other threats that cannot be ignored:

An ANC-EFF tie-up would almost certainly result in looser fiscal policy and steps that undermine the Reserve Bank’s inflation-fighting capacity. On the international stage, South Africa would probably move even further into China’s orbit.

It’s painful to chronicle how South Africa ended up in this quagmire. A long list of corruption scandals, unstable electricity supply, ballooning unemployment and an increase in violent crimes are leaving voters disillusioned. By just looking at the jobless rate in the last 30 years, which shot up to 32.9% from about 20% at the time of the financial crisis, it’s easy to make sense of the despondency  in South Africa:

The country’s GDP growth in the last decade has been sluggish, averaging 0.8% since 2012. The monetary policy tightening that followed the post-pandemic spike in activity almost sent the economy into a recession as GDP in the fourth quarter of 2023 returned 0.1%. But there are hopes that the big political moment won’t drive any major changes in policy. Bloomberg Economics’ Yvonne Mhango argues that the central bank’s focus on inflation implies high rates will continue, while easing constraints in the energy and logistics sector should soften the blow from monetary policy:

Investors are taking a wait-and-see approach ahead of South Africa’s consequential May election. Policy will likely remain broadly unchanged regardless of the outcome, allowing for ongoing reform efforts to be sustained. We are seeing gains on the infrastructure front. Logistics woes have eased. Power outages have receded. Interest rates will remain high for longer than previously expected, keeping consumption subdued. Spending on energy projects will keep investment activity robust.

South Africa’s rand, stronger recently after bouts of depreciation, faces a stern test in the election. Bloomberg Intelligence’s Sergei Voloboev, FX and rates strategist for EMEA and EM, warns that a populist turn following the elections could undo the rand, which has been a star performer among emerging currencies. South Africa remains one of the preferred destinations of Japanese carry traders thanks to continuing high interest rates, and over the last 12 months it has almost matched the appreciation of the Mexican peso, currently the most popular carry destination. That could make it vulnerable if the perceived political risks rise further:

The recent rally in platinum and gold prices has been a boon for South Africa’s economy, a major producer of the two precious metals, improving the commodities’ terms of trade. Fiscal data for March showed a decline in the government’s deficit to 4.6% of GDP (compared to a projection of 4.9%) on a 12-month rolling basis. Voloboev argues that fiscal gains, made partially possible by the rally in precious metals, provide a firm foundation for the central bank to manage inflation expectations.

Of all the possible scenarios that could emerge, a radical policy shift would clearly be the least favored by investors. As shown in the chart, over the last 12 months the country’s stock market has trailed MSCI’s indexes for emerging markets excluding China, and for the world excluding the US. If the Rainbow Nation is to attract investors, radical policies or rhetoric will likely do more harm than good — although it’s clear why some South Africans might find such alternatives appealing:

For more than 42 million registered voters, the coming elections offer a critical moment, even a call to duty to help change the nation’s path. Investors watching from the sidelines can only hope the fallout from the exercise does not come with devastating consequences. 

Richard Abbey

A Dickensian Juncture

It was the best of times, it was the worst of times, as someone once said. The latest US polls — particularly the latest from the New York Times, which has been received among Democrats much as a horror movie would be — show intensifying discontent centered on the economic record of President Joe Biden. Disillusion seems severe.

Meanwhile, investors perceive something very different. For Exhibit A, look no further than the latest global fund managers survey from Bank of America Corp., probably the most-followed measure of institutional investor sentiment. They are growing very confident:

Fund managers’ economic judgment grew very slightly more cautious compared to last month, but not by much. They now put the odds of an economic hard landing at only 11%, while a soft landing is far more likely. The possibility of “no landing,” generally held to mean that the economy expands, making it harder to bring down inflation or cut rates, is rated at 31%:

Logically enough, given that they’re positioned for a soft landing, the greatest tail risk is resumed inflation. The fund managers also fear, in a way they haven’t done at any point since BofA started asking about it in the wake of the 2008 global financial crisis, that governments are overdoing the spending. The proportion believing that global fiscal policy is “too stimulative” is at its highest since  the survey began:

A belief that governments (presumably particularly the US) are overdoing the stimulus is also clear from positioning in a range of markets. There are various ways to position for economic reflation, including buying copper, buying the Australian dollar, buying stocks relative to Treasury bonds (illustrated below by comparing the most popular exchange-traded funds tracking the S&P 500 and Bloomberg’s index of Treasuries of 20 years and more), and by buying industrial stocks relative to consumer staples. All these markets suggest that a bet on reflation is in effect — even though the US electorate evidently expects no such thing: 

The bifurcation in economic perceptions also shows up in surveys of small business. The latest optimism measure published by the National Federation of Independent Business, which polls small-business owners and has a good record as an economic leading indicator, showed overall optimism ticking up slightly. That’s slightly surprising given that small-business owners tend to be politically conservative and therefore unlikely to be impressed by the current state of the nation. 

Oxford Economics sheds light on this by splitting the NFIB survey into hard components (in which executives answer precise questions about current conditions) and soft components, in which  they express their opinion. The soft elements suggest that small businesses are braced for something terrible (the polar opposite of the fund managers). Meanwhile, the hard components suggest that the economy is weakening (so that doesn’t support the reflation trade either), but remains healthy:

It’s not at all usual for perceptions to be this deeply divided. But as institutional investors don’t have many votes, the outlook doesn’t look great for Joe Biden. 

An Inflationary Hors d’Oeuvre

A few hours after you receive this, at 8:30 a.m. on the East Coast of the US, a waiting world will learn the US consumer price inflation data for April. Tuesday brought some precursors that suggested inflation might continue to be  sticky.

In the UK, average weekly earnings growth came in at 6% year-on-year, unchanged from the previous month. That’s far above the latest reading on inflation, and naturally will tend to make the central bank less comfortable about easing rates:

As a general rule, slaying inflation requires keeping interest rates above the rate of wage growth, as demonstrated here by Absolute Strategy Research’s Ian Harnett. Under governor Eddie George, the Bank of England slayed inflation in the 1990s by keeping policy rates persistently above inflation in unit wage costs:

Post-Brexit, labor shortages in the UK have kept pricing pressures high, but the disappointing numbers had little impact on gilts. Meanwhile, in the US, Tuesday brought news of April producer price inflation. Again, this was higher than expected, ticking up to the highest level in a year. That said, PPI remains unremarkable by historical standards. It’s been measured on a final demand basis since 2011; the chart below shows this measure, plus the finished goods basis which had been used before and is still regularly calculated:

When  a major measure of inflation rises, and exceeds expectation, that’s bad news. However, there were extenuating circumstances. The increase to 0.5% in month-on-month inflation was in part because earlier months were revised lower, and the elements of PPI that are used in the calculation of the personal consumption expenditures index, the Fed’s official target, were relatively restrained. It was soon dismissed as nothing to worry about. 

Either way, the lack of response in the markets most affected by rates and inflation was telling. The 2-year Treasury yield, sensitive to short-term moves in the fed funds rate, actually fell slightly. That’s partly because the number could have been worse, and mainly because there’s still  a reluctance to take any emphatic position before the CPI comes  out. Since the beginning of April, all the moves in the 2-year yield have been driven by the March nonfarm payrolls and CPI reports, both of which were higher than expected, and the April payrolls, which came as a relative relief. There’s been plenty of other news, but it’s been dwarfed by inflation and unemployment:

The consensus expects a reduction in annual inflation for April, while the whisper on Wall Street is that it will come in lower than that forecast. Ahead of that, nobody wanted to take the 2-year yield higher. Whatever the number, the odds are that CPI will provoke a much sharper reaction. We’ll soon know. 

Survival Tips

David Byrne of the Talking Heads turned 72 on Tuesday, which is unreal in itself. Evidently many believe we’re on a Road to Nowhere (which had one of the best videos of all time). As a retort, try listening to an early Talking Heads song, Don’t Worry About the Government. Or for something less topical but always worth listening to, try The Big CountryOnce in a LifetimeThis Must Be the Place or Blind. It’s quite a catalogue, and there’s a reason people still listen to it. Happy Birthday David. 

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