By Sameer Sharma
While the global economic outlook remains weak especially in Europe, every single major asset class, bar the dollar index and the commodities index, are up year to date. These asset classes have even beaten holding onto US dollar cash this year. The S&P500 is up 7 percent, the tech heavy NASDAQ is up 19 percent, high grade US corporate bonds are up 4 percent, US high yield credit is up 3 percent and even US treasuries are up 2.8 percent. The disruptive technologies space, from crypto to space tech, is up between 10 percent and 75 percent.
This is all in contrast to what happened in 2022. This is simply because markets attempt to be forward looking and have priced in some 55 basis points of US rate cuts in 2023 and another 170 basis points of cumulative US rate cuts in 2024. This pricing of the interest rate path ahead is dragging the dollar lower, pushing risk assets higher and even allowing longer duration bond trades to partially recoup their 2022 losses.
Even local currency emerging market debt is up close to 4 percent so far this year in dollar terms, given peaking emerging market bond yields as emerging market central banks near the end of their respective tightening cycles.
The market pricing of Fed easing later in the year is likely misplaced. The US labour market still remains tighter than expected, services inflation remains high, and the impact of a tech earnings recession, US regional banking and commercial real estate woes on the real economy are all more a 2024 than a 2023 story given time lag effects. US rates have a moderate chance of seeing another 25 basis point increase in May 2023 when it will peak out.
We are only likely to see US interest rate cuts in 2024 given that the start of the long-awaited date of a US recession has been pushed back to late 2023 and into 2024, as opposed to the earlier forecast of June 2023. As 2024 edges closer, we should begin to see more selling pressure on risk assets as economic indicators worsen in a more meaningful way with many investors likely to book profits by the middle of the year.
Normally when the world is expected to enter into a significant slowdown, the US dollar tends to strengthen as investors seek the safety of US treasuries. This time, things will be different and it has nothing to do with geopolitics. Inflation will remain relatively stickier, and the distance to target inflation will remain higher in Europe and the United Kingdom, compelling the European Central Bank and the Bank of England to keep rates higher for longer compared to the Fed which will delay rate cuts in 2023 but meet 2024 market expectations as recession pressures increase and job losses begin to mount and relieve inflation pressures in the United States.
This will keep the dollar under pressure relative to these currencies. European real interest rates are more in negative territory than those of the United States, and ultimately the fight to tame inflation is about expected real interest rates and bringing them to slightly positive levels. The US will be in a better position to cut in 2024 than the Europeans will.
Emerging market economies, especially those in Asia are currently benefiting from the Chinese re-opening and will likely see their currencies strengthen against the dollar as well. The current account deficit in the US being close to 5 percent annualized won’t help matters either.
So where does all this leave the Mauritian monetary policy and the rupee?
For a responsible fiscal policy
The recent OPEC oil production cuts have pushed Brent crude oil prices moderately higher. The current account deficit of Mauritius, which stood at 12 percent of GDP in 2022, is expected to remain at an elevated 10 percent of GDP for 2023 despite a recovery in exports and tourism earnings. Inflation in Mauritius, especially core inflation, remains well above the central bank’s upper bound target. Inflation should end the year above 6 percent, and hence real interest rates will remain quite negative.
The Bank of Mauritius will continue to impose quasi-capital controls in the country.
The current monetary policy stance in Mauritius is not in line with the central bank’s new framework but then again, the Monetary Policy Committee has not met since December, fiscal dominance remains strong and given the sheer size of public and private debt on top of the size of unfunded liabilities, real interest rates should remain negative for an extended period. The Mauritian economy will likely clock between 4.5 percent and 4.8 percent this year and continue to converge to its 3 percent potential rate of growth in 2024 with inflation remaining persistent.
It is also clear that the Bank of Mauritius can only do smaller foreign exchange interventions now given liquidity constraints and structural challenges. The central bank so far this year has sold a fraction of dollars in a month that it used to sell in a day in 2022. Given the self induced liquidity constraints within international reserves, the Bank of Mauritius will continue to impose quasi-capital controls in the country and use as much stick as it can get away with.
Taking global dollar dynamics and the domestic factors enumerated above into account, the Mauritian Rupee has likely already peaked out against the US dollar in the short term but will likely be trading at lower levels compared to the Euro and select Asian emerging market currencies. Downside risks to the outlook of the Rupee’s relative stability against the dollar (and relative weakness against other major currencies as highlighted above) would materialize should the 2023 national budget be more populist than responsible, especially when it comes to the use of printed central bank money found in special funds, which would worsen the current account deficit.
Given the unwillingness to tighten monetary policy, given domestic debt concerns despite still high negative real interest rates, responsible fiscal policy involving a combination of targeted tax increases and spending cuts are necessary. Else the strategy of a populist budget coupled with more draconian 1980s style capital controls will continue to worsen, which is certainly not in the strategic interest of this so called Mauritius International Financial Centre.