An overview of the global economy May 2023

Over the past few months global markets have been volatile; given the geopolitical factors, market events, and earnings reports.

By now, we understand the impact that the global pandemic had; forcing many countries to loosen their monetary policy to unrealistic levels. Since then, it's been a race to bring stability to currencies and to combat inflation as central banks raise interest rates.

A rise in rates may create a slowdown effect on an economy. This comes down to various companies, especially those heavily exposed to the fixed-income market. The collapse of banks like Silicon Valley Bank, as a result of rising rates, has kept investors on the lookout for other big names that show signs of falling. The US is one of the world's largest economies that has a debt ceiling of $31.4 billion. The era of free money (more printing of money), along with other factors, has put the US economy into a position where it has the potential to default on its repayments. Like any other country, the US has debt obligations to its bondholders. As of 25 May 2023, the US treasury closing balance was $38 billion, and it could run out of money as soon as June 1 to pay all its bills.

During the weekend, US President Joe Biden and House Speaker Kevin McCarthy reached an agreement "in principle," which is expected to be voted on by Wednesday. Details of the deal are not revealed, although various media outlets reported that the debt ceiling may be suspended, allowing the government to borrow more, through to January 2025, with a spending cap in the 2024 and 2025 budget.

At this point, borrowing to pay debt may be feasible to meet short-term debt obligations but won't be sustainable in the long term.

Let's speak capitalism...

In the system of capitalism, debt obligations must be honoured, and as we know, bonds are a debt instrument that enable investors to lend government money for development, etc. Interest rates play an important role in this. When the cost of borrowing rises, this tends to decrease the appetite for borrowing for that specific country. In the bond market this would lead to a drop in bond prices while yields leap higher. The period in which a central bank starts to cut rates (from the peak) may differ from one country to another, depending on whether the inflation target is met. Locally, the inflation target is between 3-6% (currently, the inflation rate sits at 6.8%).

On Thursday, the South African Reserve Bank announced 50 bps to 8.25%, the highest range since 2009.

Bond Exposure 

A peak in rates may result in a bond market rally.

The Satrix GOVI ETF exposes investors to the South African government fixed income (credit) markets: the GOVI Index (top ten of the FTSE/JSE All bond index). It's worth noting that the interest rate decision is also influenced by various market data points, which include job claims, price indexes, and forex exchange, to name a few. These are some of the data points that may help indicate where interest rates may be heading.

The 1nvest Global Government Bond Index Feeder ETF looks at the G7 countries (through the iShares Global Govt Bond UCITS ETF), which include the United States, Germany, Japan, the United Kingdom, France, Italy, and Canada. The US rates were previously increased by 25 basis points. Germany, France, and Italy interest rates are decided by the European Central Bank (ECB). In the previous meeting, they raised rates by 25 basis points. The United Kingdom (Bank of England) raised rates by 25 basis points. Japan and Canada rates remained unchanged.

In case you missed it, we recently added the first actively managed ETF (CoreShares Income Actively Managed ETF). The fund invests in the fixed-income market, both locally and internationally. An ETF like this could also help diversify one's fixed-income market exposure. Here's a InstaLive we did around this actively managed ETF.

Commodities 

Taking into consideration all the uncertainties in the global economy, work must continue to maintain and contribute to an economy's stability, which brings us to commodities.

Commodities have been the talk of the town, primarily because of the fact that they are involved in our daily lives and manufacturing. The Chinese economy opened its economy in January 2023, following the long zero Covid policy. Despite weaker demand (coming from higher rates at a global scale), Chinese manufacturing data was maintained above average. Its interest rates have remained unchanged, and this may result in an acceleration in economic activity.

Iron Ore and Steel are vital in manufacturing, and markets have been optimistic about the demand that may come from China's reopening. It's interesting to note that China's population has been declining, which may hamper its position as the global manufacturing hub in the long term. Despite this, Máximo Vedoya, World Steel economics committee chair, explained in an addition of Creamer Media's Engineering News, that as China's population and demand for steel decline, the future of steel demand growth will be driven by emerging economies in Asia and investments in decarbonization. BHP Group Limited is a multinational miner (the largest by market cap). It engages in base metals (including Iron Ore and Steel) and coal, production of oil and natural gas, and provides potash for agricultural purposes.

ArcelorMittal South Africa Limited is one of the locally known names that has been highlighting concerns surrounding including high imports from China with very low prices in its latest financials. South Africa has announced new flat steel capacity and new long steel capacity, trying to benefit from the scrap export ban.

In its latest results, ArcelorMittal said, "It is best placed to advance these opportunities, localization of value-added steel production opportunities, given its existing asset base. Improved building activity… However, a government growth agenda is now sorely needed to add the necessary momentum."
It's not a secret that many countries seek mineral resource independence.

At this point, we can see that the effects of rates result in consumers spending less. The demand side may flip as countries around the world go to work while racing towards a green economy. LNG, copper, lithium, and uranium are four commodities vital in the energy space. 

Given its contribution towards a greener economy, copper has been classified as the future oil. Economists have also started anticipating a shortfall in supply as demand rises from the green economy transition. Big players like BHP Group may be well positioned to run the rally along with copper prices in the short term; it acquired OZ Minerals, an Australian copper miner, earlier this year. Penny stocks like Orion Minerals could also hold great potential to be part of the value chain of copper through the Prieska Copper-Zinc Mine and the Okiep Copper Project in the Northern Cape province in South Africa (an area that was historically rich with copper). It plans to start producing copper in 2024.

Lithium is another commodity getting caught in the political back and forth between different countries, especially the US and China. Pilbara Minerals Limited may be one company well positioned amid the geopolitical tensions, where we could see the demand being fueled by "Made in America" and "Made in China" campaigns that require significant amounts of lithium, along with other metals. On May 23, 2023, Dale Henderson, the CEO of Pilbara Minerals Limited, said the company is aware of the US-China rivalry on minerals. He added, "I don't foresee China making any detrimental move to increase the distance between Australia and China in respect of raw materials, particularly within the lithium supply chain because it would hurt them massively... their industries are very dependent on Australia, and we have a very co-dependent relationship."

According to Financial Review, talks at the G7 summit in Japan were also around giving Australian miners and green producers greater access to the US.

Uranium is vital in renewable energy and other defence uses. Paladin Energy Limited is a partner with China Uranium Corporation Limited at the Langer Heinrich's uranium mine, a Namibian mine, which is expected to be back in production in 2024.

Looking at liquefied natural gas, the supply of LNG has been caught in the crossfire given the geopolitical tensions in the West. In September 2022, Renergen Limited commenced its liquefied natural gas (LNG) production and plans to ramp up production in 2026. The funding for this may be further boosted by its potential US listing.

Conclusion:

Volatility in the market may be introduced as a result of the US debt uncertainties; a default has an impact on a country's creditworthiness, leading to a downgrade in its credit rating. It may also be worthwhile looking at where the country's spending will be. This could potentially be good news for volatility indexes.

On the other hand, raising the debt ceiling may allow the US economy to meet its short-term debt obligations, and this may result in a short rally in the stock market. The government taking on more debt may result in higher rates. Central banks rely on various data points, which include price indexes, job claims, gross domestic product, and more.

The work of an economy, such as expanding exploration projects and development, may be required to prevent other inflation pressures, such as "energy inflation",  which is a sustained increase in the cost or price of energy resources such as electricity, fuel, or natural gas. As investors, paying attention to economic data and fiscal policies and management of the major economies could help investors ride the wave and align it with their financial goals. Political relations between different countries may be worth keeping an eye on as these can also paint a picture, looking at the trade relations ahead of the 2024 elections.

Sources – EasyResearch, Orion Minerals Limited, Pilbara Minerals Limited, Financial Review, BHP Group, Trading Economics, Paladin Energy Limited, Daily Treasury Statement,Creamer Media Engineers, 

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