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The world has seen an unprecedented period of low interest rates in the wake of the 2007 to 2009 recession. Led by the US Federal Reserve, most developed and even emerging-market economies dropped their benchmark lending rates to historically low levels in a bid to boost lending to consumers and companies.
The US economy benefitted from these low borrowing costs, seeing unemployment fall from 10% in October 2009 to 5.1% in September 2015, according to the Bureau of Labor Statistics. Low yields in the world’s largest economy drove investors to allocate their funds to riskier assets, such as emerging markets, including South Africa.
China’s economy recovered quickly after the recession and the central government in the world’s second-biggest economy started a process to steer the country away from being the factory of the world, to one where its own citizens drive growth through consumption.
This inevitably led to a slower growth scenario, where less investment in infrastructure to produce and ship goods to the rest of the world impacted growth. Raw materials, sourced in the mineral-rich developing world, are less in demand and emerging-market assets, such as equities, bonds and currencies, have been hit hard over the past couple of months.
This, coupled with the prospects of higher interest rates in the US – which would see investors pulling their money back to the less risky home soil – has dimmed the prospects of emerging-market assets.
Currencies were hit: the Brazilian real has depreciated by 31.6% against the dollar this year, the rand by 15.1%, the Turkish lira by 19.8%, the Indian rupee by 2.7%, the Indonesian rupiah by 8.6% and the Malaysian ringgit by 17.8%.
Stock markets also came under pressure. The benchmark index of Brazil fell 4.8% since the beginning of the year; Malaysia’s stocks are down 2.9%; Indonesia’s slumped by 11% and SA’s All Share Index, dearly priced at 19 times earnings, rose 9.1%.
“If the Fed decides to lift interest rates, it implies that they expect the US economy to continue strengthening,” says Jean Pierre Verster, fund manager at 36ONE Asset Managers, who oversees SA’s largest hedge fund. “But, in general, the rest of the global economy is not strengthening.”
Concerns about a rate increase in the US would spill over to SA, which would probably see an outflow of money as investors repatriate funds to the US. This could prompt the Reserve Bank to follow the Fed, increasing the repurchase rate in a bid to protect the rand.
“In SA, a rising interest rate is needed to protect the rand,” says Brendon Hubbard, a fund manager at ClucasGray, an investment and asset management company. “Interest rates should, theoretically, only increase when the economy is strong enough to handle it.”
The Reserve Bank has raised interest rates three times and by 100 basis points since 29 January 2014, mainly to preserve the value of the rand. Nevertheless, the currency depreciated by 18% against the dollar over the same period.
Against this background of a US-led interest rate hiking cycle, and the emerging markets, bar China, following suit, asset managers’ opinions are divided about where to put investors’ money to secure continuing returns.
Emerging markets
The People’s Bank of China, the monetary authority of the world’s second-largest economy, decided to cut its benchmark lending rate by 25 basis points, or 0.25 percentage points, on 23 October.
This followed on the Fed’s decision earlier that week to keep US interest rates on hold near 0% due to concerns about emerging markets and what the implication would be on their economies.
The Fed and Bank of China’s actions during that week were in reaction to a warning from the International Monetary Fund’s (IMF’s) chief about the effects of China’s economic transition and the Fed’s imminent rates increases on developing markets.
This is an excerpt from an article that originally appeared in the 5 November 2015 edition of finweek. Buy and download the magazine here.
