Just when South Africa thought it was entering calmer waters, volatile international geopolitics and the prospect of higher oil prices, stickier inflation and slower interest rate cuts by the US Federal Reserve are threatening our nascent economic recovery.
With the Middle East on the cusp of a regional conflagration, oil markets have become jittery. The oil price has whipsawed around the $80 a barrel (bbl) mark over the past week.
But nobody is panicking — yet.
Though oil prices are up about $10/bbl since the end of September, economists have been quick to pour cold water on fears that the world could be heading for a replay of the 1970s oil price shocks (sparked by the Yom Kippur War in 1973 and the Iranian Revolution in 1979) in which the real price of oil increased 10-fold in 10 years.
The chief worry is not that Iran may be unable to keep producing its 3-million barrels of oil a day, since other producers could step up production to counter that, but that Iran could respond to potential attacks on its infrastructure by impairing maritime traffic in the Strait of Hormuz, a vital chokepoint through which most Middle Eastern oil is transported.
That would be an extreme response, not to mention economic suicide for Iran, and is something all sides, including the US and China, are expected to take great pains to avoid.
In the absence of this worst-case scenario, the consensus is that the price of oil is unlikely to shoot above $100/bbl given the ample spare capacity that exists among Opec members (see graph); slowing global demand, especially out of China; and the accelerating shift to electric cars.
In fact, before the latest escalation in tensions in the Middle East, traders were expecting an oil glut to push prices below $70/bbl next year, given reports that Saudi Arabia was considering abandoning Opec production cuts in a push to gain market share.
But while the prospect of oil at $100/bbl or $130/bbl (as was the case in the wake of the Russian invasion of Ukraine) is widely considered unlikely, any escalation in the Middle East conflict would put further unwelcome upward pressure on oil prices.
The fear is that if oil prices rise further, it could disrupt the disinflation process under way in emerging markets, says Elijah Oliveros-Rosen, chief emerging-markets economist at S&P Global Ratings. This could slow down or delay monetary policy easing.
“This is especially true for major net energy importers, as the potential for associated weaker external accounts could keep central banks more cautious towards lowering rates to prevent disorderly capital outflows,” he says in a research note.
South Africa, a net energy importer, has faced a double whammy over the past week as the move in the oil price above $80/bbl was accompanied by the rand weakening — typically a red flag for the Reserve Bank.
The rand was actually reacting not to the oil price moves but to the second major event to hit the global economy: surprisingly strong US jobs data.
This, in addition to the rise in oil prices, is causing markets to anticipate a less aggressive Fed easing cycle. The shift in market sentiment is bolstering the dollar and, in turn, weakening the rand.
In recent weeks, the rand pushed out to R17.64/$ from R17.03/$ at the end of September, though it has since consolidated below R17.50/$.
The upshot, says Investec economist Annabel Bishop, is that the R1 a litre petrol price cut South Africa was expecting in November has been eroded to a cut of just 39c/litre. If the oil price keeps rising, South Africans could experience a petrol price hike in November, instead of the expected cut, she warns.
This would clearly be negative for inflation. But we shouldn’t get ahead of ourselves.
Old Mutual Wealth strategist Izak Odendaal remains sanguine, noting that oil at $80/bbl-$90/bbl isn’t a worrying level for South Africa. At the current level of about $78/bbl, oil prices are still 8% below levels from a year ago and 18% lower in rand terms.
“At these levels, oil is still detracting from headline inflation rates, not adding to them,” he points out.
The Fed factor
For Odendaal, the bigger driver and bigger risk remains the cooling of the US economy and the behaviour of the Fed.
The surprisingly strong September US payroll number and drop in the unemployment rate from 4.2% to 4.1% means the Fed is now unlikely to cut the policy rate by 50 basis points (bp) in November, as was widely expected. However, a 25bp cut is still on the table.
“I think the Fed will continue to reduce rates, but markets got a bit ahead of themselves in expecting more jumbo cuts,” says Odendaal. “This means the dollar has firmed up a bit and the rand has pulled back after a strong run. Again, these moves are not worrying from a South African point of view, and do not meaningfully alter the inflation outlook.”
He feels the rand would need to weaken back to R18.50/$-R19.50/$ territory before South Africa would need to worry about inflation reviving and the Bank abandoning its cutting cycle. And to get there would probably require a complete repricing of the Fed’s cycle, which is not on the cards.
The biggest risk to the inflation outlook at this stage is probably home-grown — Eskom’s 36% electricity tariff application — rather than anything the international situation is throwing up.
Citadel chief economist Maarten Ackerman has a similar view. Citadel’s base case is that the price of oil is likely to stabilise around current levels as long as there isn’t a huge escalation in the Middle East conflict.
“The situation would have to deteriorate significantly for oil to go over $100/bbl,” he says. “While this is a possible scenario, it seems likely that Opec would prevent it from running that far.”
If oil did go over $100/bbl it would be “problematic” for South Africa as it would not only raise domestic inflation but lead to a risk-off episode in global risk appetite and a slowdown in global demand that would negatively affect South African exports and the rand.
“That would be a red flag for the Bank, suggesting that inflation could become sticky over the next 12 to 18 months, which would make it more cautious about cutting rates,” he says.
The good news
Given these mounting risks, the fact that China has just announced a stimulus package to keep its stalling economy growing by about 5% a year couldn’t have come at a better time.
Unfortunately, the stimulus announced so far falls short of the bazooka the markets have been demanding. While it could give a nice little boost to Chinese economic activity into 2025, the package doesn’t seem set to give rise to the kind of infrastructure-intense investment spending that would significantly raise the demand for, and prices of, South African export commodities.
Still, China’s fresh stimulus does underscore the fact that there is now a strong easing bias in many of the world’s major economies. This will provide a positive backdrop for financial markets, provided the geopolitical environment doesn’t deteriorate much further.
In short, the global environment is still more favourable for South Africa than it was six months ago. This, combined with ongoing domestic structural reforms and lower domestic interest rates and inflation, should deliver faster growth over the medium term.
Clearly, a dramatic escalation in the Middle East could change things, but as The Economist magazine puts it, “a lot of things would have to go very, very wrong” for oil to reach triple digits again.
Odendaal reminds us that, of course, in economics things rarely move in a straight line.
“There will be surprises in the data some months, there will be volatility on markets, and there will be tensions in the government of national unity,” he says. “However, South Africa’s green shoots should continue growing.”