While 2024 began with the US interest rate markets pricing for up to seven interest rate cuts during the year, by the end of the first quarter these expectations had been scaled back to only three cuts. The US market is awakening to the reality of a strong labour market, low unemployment and sticky inflation in US services. Such stickiness in US prices makes it incredibly difficult to cut interest rates without lighting the flame of another round of inflation.
The drivers of US services inflation over the last few months cover quite a range of items, like costlier prices for elder care and domestic work, hospital and veterinarian services, financial services and even admission to sporting events. When an economy experiences an energy, food and fuel price shock, as seen in 2022, then it is natural to expect that a second-round shock via services-led inflation could follow. When prices have been high, workers demand higher pay.

This is particularly true for an economy with a shortage of low-skilled labour, like the US. When in short supply, lower-cost labourers have a lot of bargaining power. US wage growth is unsurprisingly still running at an elevated 5.4% year-on-year with 8.8 million job openings versus only 6.4 million unemployed workers.

Inflation is also proving to be sticky in South Africa, and it is no surprise that the South African Reserve Bank (SARB) voted unanimously in March to keep the repo rate unchanged at a 14-year high of 8.25%. Last year, South African food inflation hit its highest levels since 2008. Drought-like conditions are emerging, not just in parts of the country, but across the continent, doing damage to crop yields and maize harvests.

El Niño and bean disease have caused official cocoa production numbers to fall by 20% to 40% in Côte d'Ivoire and Ghana, which are responsible for a combined 60% of global cocoa bean production. As a result, the price of cocoa per metric tonne has tripled in the last year which will bleed into confectionary prices in time.

The SARB has also been at pains to highlight that high administered regulated price inflation, such as for electricity, water and property rates, puts pressure on prices in a way that is outside of the SARB's control, given these prices are not being adjusted with demand but rather with the broken balance sheets of state-owned enterprises (SOEs) and municipalities. In February, South African consumer prices rose by 5.6% year-on-year, more than a full percent wider than the SARB's preferred level.

Unpacking this figure further, inflation in the Western Cape increased to 6.3%, given a greater weighting towards services categories like medical insurance, which rose by 13%. In provinces like Limpopo, headline inflation was notably lower at 4.4%, given a larger weighting towards basic food and fuel which is disinflating from the high base created in 2022.

The sticky nature of inflation in South Africa lessens the probability that the SARB will cut interest rates any time soon or, if they do, it raises the chances that it will be a short cutting cycle. In this regard, the local market continues to price for only one interest rate cut over the next two years.

Over the last quarter, the Fund again raised its exposure to Treasury Bills as yields remained higher than bank deposit rates due to government's large funding requirement. Bank appetite to pay up aggressively for deposits tends to wane when they are writing fewer loans, and we have seen this occur as bank non-performing loans rise, and they subsequently rein in their credit appetite.

The weighted average yield of the Fund (gross of fees) ended the quarter at 9.47%, paying the highest rate of interest in the Fund in over 14 years.