SA can expect good and bad economic news from the US in 2023.
The good news is that US inflation is likely to come down sharply this year. That will enable the Federal Reserve to pivot away from its hawkish monetary policy stance. This should lead to considerable weakening in the dollar from its 20-year high. If that occurs, present downward pressure on the rand will dissipate, removing an important source of SA inflationary pressure.
The bad news is that the Fed’s success in taming the inflationary beast is most likely to come at the cost of a meaningful US economic recession. That could be particularly problematic for world financial markets in that any US recession would be occurring at a particularly bad time for the world economy. Europe will be struggling with its recession as it struggles with a Russian-induced energy crisis. The Chinese economy will continue to stall as it contends with its Covid challenge and a property market bust. Meanwhile, many emerging market economies will be defaulting on their debt mountains.
Among reasons to expect a sharp fall in US inflation are the large price drops already in evidence in the US housing and used car markets in response to sharply higher mortgage and consumer loan rates. In much the same way that sharp rises in prices of these items added to inflation last year, so too will sharp falls this year subtract substantially from US inflation.
There are further good reasons to expect that US inflation will moderate to the Fed’s 2% inflation target. The US will benefit from the recent drop in oil prices globally from $120 a barrel to $75 that has already been reflected in a fall of more than 30% in liquid fuel prices. At the same time, US import costs will drop as a result of the dollar’s appreciation of more than 10% since the start of last year, while US wage pressures should moderate as the US slides into recession and unemployment starts to climb.
Among reasons to expect that the US economy to move into recession is that seldom before has the Fed raised interest rates as rapidly as it has over the past nine months. Instead of raising interest rates by the more normal 25 basis point steps of previous interest rate hiking cycles, last year the Fed hiked interest rates on four occasions by 75 basis points and in December by a further 50 basis points. Those hikes have led to mortgage rates more than doubling from 3% at the start of the year to almost 7% now, which has already led to recessionary conditions in the US housing market.
Heightening the chances of a recession this year is that even at a time when the US economy is already slowing, the Fed is committed to keep raising interest rates until it sees the clearest of signs that inflation is coming down towards its inflation target. By so doing the Fed seems to be ignoring lessons from past episodes of monetary policy tightening that monetary policy generally operates with long lags.
The Fed also seems to be overlooking that its current monetary policy is tightening while US budget policy shifts from unusual ease to unusual restraint. This budget policy shift heightens the chances that the Fed is now engaging in monetary policy overkill to regain inflation control.
All of this suggests that now is not the time for SA policymaker complacency. To be sure, falling US interest rates and a weaker dollar should provide welcome relief for a battered rand. However, if the US leads the world into a meaningful economic recession we should brace ourselves for turbulent world financial markets that will be particularly challenging for countries whose public finances are not in order.