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When the Fed starts to hike…

Policy divergence will drive markets in year ahead – SEI Investments.

JOHANNESBURG – Policy divergence will be one of the major themes driving markets in the year ahead.

This is according to Cai Rees, director and client investment strategist at SEI Investments. SEI is a Nasdaq-listed multi-manager, which serves about 25 clients in Southern Africa – mostly pension funds – through its Johannesburg office.

Rees says while policy divergence has been expected for some time, it now seems to be on the horizon – especially if the US Federal Reserve starts to hike rates in December on the back of improved jobs and inflation data.

With the US on the verge of hiking rates, the UK likely to raise rates and Europe and Japan trying to keep rates low while also contemplating more quantitative easing, there is likely to be a divergence of policies that global economies haven’t experienced for quite some time, he says.

Investors should expect markets to go through volatile periods as they try to digest the impact of these diverging policies.

“I don’t see any systemic problems with this – it is just it will need to be managed and you will want to be in the right sectors for this,” he says.

Emerging markets may also struggle initially and are expected to take “a couple of hits” following a rate hike in the US.

Rees says a lot of emerging markets need to refinance their debt and the refinancing rate is usually in some way related to the US interest rate. If interest rates in the US are rising and the dollar soars, emerging markets could also find that the cost of refinancing their existing debt increases.

There is also a risk that policies could start to diverge to such an extent that countries who are at a different point in the economic cycle and not ready to start hiking rates yet, may be forced to do so.

The South African Reserve Bank’s Monetary Policy Committee (MPC) is due to announce its decision on interest rates next Thursday after it kept rates on hold in September. At the time, governor Letsetja Kganyago, said the extent to which US policy normalisation is already reflected in the currency remains uncertain.

“The fact that the rand appreciated in response to the Fed decision [to keep rates on hold in September] suggests that some depreciation is likely when US rates are increased. However, the extent is uncertain, with the possibility of a temporary overshoot in a highly volatile environment,” he said.

Another theme markets will keep a close eye on is the slowdown in the Chinese economy.

Rees says the Chinese government has a lot of work to do to manage the slowdown. Some of the reasons global markets got spooked during the third quarter was because the Chinese government unsuccessfully intervened in the stock market and devalued the currency without prior notice.

It took some time for the market to gain confidence that it wasn’t going to devalue the currency much further.

“If China devalued their currency that would really hurt South Africa and emerging market currencies.”

Additionally, commodity exporters like South Africa should not expect the same level of assistance China provided during its economic heydays, Rees says.

China is moving from an industrialised to a consumer-lead economy and quite recently overtook the US with about 110 million middle-class people compared to roughly 90 million in the US.

Rees says even though there is still a certain amount of poverty in China, the country does have the middle class base to create this consumer-led economy.

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Weren’t we having this same debate 2 years ago.I’ll believe it when it happens!

When Cai says “I don’t see any systemic problems with this”, does this mean that the Fed has now successfully bought the majority of the long-term interest rate derivatives issued pre-2008 (2006?) that one would expect to blow up if the Fed were to raise rates in any meaningful way?

It would also suggest that he is confident that there aren’t significantly leveraged long private positions in bonds, of any real size.

Although I speak from a position of ignorance, I would not want to bet that either of those necessary conditions are valid.

End of comments.

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