Stimulus taper adds to Omicron damage

The Omicron variant could hardly have come at a worse time for SA, not because of the tourism season but also because of the taper. The one will damage SA’s fragile economic recovery; the other will further narrow the space for SA’s monetary and fiscal policymakers to support that recovery.

There are still more questions than answers about Omicron and how severe and vaccine-resistant it will prove to be. But even if data emerges in coming weeks to allay some of the concerns, it is already too late to salvage the much-needed summer influx of foreign tourism that would have been ramping up about now, for the first time in two years.

Together with the chilling effect of this fourth wave of Covid-19 caused by Omicron on domestic activity, this will weigh on fourth-quarter growth

— compounding the sharp third-quarter decline which Tuesday’s GDP figures are expected to show.

But if domestically Omicron ’ s timing was unfortunate, an unfriendly global environment has made it even more so. The rand exchange rate and bond yields were already under pressure at the prospect that the US Federal Reserve (Fed) would have to start withdrawing its huge crisis-era stimulus measures faster than expected. But “Omicron Friday” on November 26 came as that prospect was gaining traction, with US inflation having climbed to 6.2% in October and growing evidence that the Fed is concerned that this might be more persistent than transitory, forcing it to start slowing its tapering plans.

With the US unemployment rate now having fallen to an enviable 4.2% and Fed chair Jerome Powell telling the US Senate this week he no longer believes inflation will be so transitory, it is likely the Fed will use its mid-December meeting to announce more aggressive taper plans than the gradualism it promised earlier this year. After the taper will come increases in US interest rates, which now is likely to be sooner than expected.

The prospect of all that has strengthened the dollar, and weakened the risk appetite of international investors. SA and other emerging markets had already seen their currencies and equity and bond markets take strain, with the Institute of International Finance estimating that nonresident portfolio inflows to emerging markets, excluding China, came to a sudden stop in the three months to November.

Then came Omicron to amplify that. It put global markets into a spin and hit SA especially hard. The rand losses spiked to a peak of R16.37/$ on Omicron Friday, though it has rallied somewhat since, to just below R16. At some point it went from being one of the best-performing emergingmarket currencies this year to one of the worst.

The benchmark 10-year SA government bond maturing in 2031 spiked to a peak yield, which moves inversely to the price, of 10.2% on Omicron Friday and though it has now rallied to about 9.8%, that’s still above the 9.5%-9.6% at which it was trading about the time of the medium-term budget this month — making the government’s longer-term borrowing significantly more expensive than an ordinary home loan, and in real terms one of the most expensive in emerging markets.

At a macro level, the market’s gyrations will narrow the options for both monetary and fiscal policymakers. The Reserve Bank will be eyeing the potential inflationary consequences of a weaker exchange rate as it makes interest rate decisions in coming months. Inflation is already up to 5%, from the 3.2% it averaged in 2010. The fuel price, up 40% year on year, is the big driver and monetary policymakers will have to make a call on where that will go — balancing the effect of a weaker rand with the Omicron fears’ reduction of global crude oil prices.

Most other emerging markets have started hiking rates amid inflation fears and though SA inflation remains more controlled than most, its dynamics have already seen the Bank embark on an interest rate hiking cycle. The hope is it will be gradual and shallow.

But global factors could make it hard to keep it that way, which could be a real risk in an economy now likely to be weaker than expected. The market is pricing in about eight interest rate hikes over the next 12 months, even though the Bank itself and most economists see a less aggressive scenario.

Likewise fiscal policymakers are up against government borrowing costs which are now even steeper than expected at the time of the medium-term budget, and could consume even more of the revenue government should ideally be using to support lives and livelihoods as the economy slows into the new year.

The government also has to worry about the availability of capital on international markets, given how much it continues to have to borrow.

It’s not a happy picture. On the upside, though, Omicron has prompted a big pickup in SA’s vaccine drive, with much stronger messaging from the government and moves to mandates by the private sector. That should help mitigate the health and economic impact of the variant.

And it’s still possible to hope for the best case scenario in which this variant proves so transmissible that it dethrones all others — but so mild that it’s hardly worse than the flu.

10.2% the spike to a peak yield in the 10-year SA government bond maturing in 2031 on Omicron Friday