On Wednesday 23rd August, the SA inflation rate for July was announced as 4.6%, down from 5.1% in June. Inflation has been declining steadily since topping out at 6.8% in December last year and you will have to go back to September 2015 to find this level of inflation again. This drop was mainly driven by the large decline in petrol prices and boosts the odds of seeing another rate cut in September.
Before we focus on the next interest rate cut, it is important to have a look at how the SA-US carry trade has changed over the past month. The positive spread of the real SA prime rate (interest rates less inflation) over the real Fed funds rate provides an incentive for foreigners to invest in South Africa. It is as simple as borrowing at negative or low real rates in US$ and pocketing positive or greater yields in SA. These inflows are important for South Africa as it provides support for the rand in a very unstable environment and assists the government to fund their twin deficits.
Since our last article, SA-US Carry Trade Remains Positive, the SARB announced an interest rate cut of 25bp and the SA inflation rate dropped to 4.6% for July. The US printed an inflation rate of 1.7% for July which was 0.1% below expectations. This disappointing figure will delay the decision of the Federal reserve to hike interest rates for a third time this year. These figures combined resulted in an increase in the SA-US carry trade from 5.75% in June to 6.1% in July (shown in the figure below).
(Click Image to enlarge)
Source: Fred Economic Data, SARB
For South Africa, this should provide well-needed rand support following yet another political event that caused harm to our local currency. A downtrend in local inflation is evident, but this also enhances the likelihood of another rate cut this year. The net effect should be a relatively stable real prime rate for South Africa. The US, on the other hand, might not see another rate hike as soon as was expected earlier this year, and inflation figures have been sluggish. The result? The SA-US carry still doesn’t cease to amaze, and continues to provide profitable investment opportunities in South Africa.
Joani van Wyk
Joani van Wyk joined the asset management team in January 2017, responsible for quantitative research of equities across all industries. Joani completed her degree in Mathematical Science in 2015, as well as an Honours degree in Financial Risk Management in 2016, both at the University of Stellenbosch. She is currently a CFA candidate.