Episode Transcript
The Finance Ghost: Welcome to episode 287 of Magic Markets. We are talking inflation this week, both internationally and here at home in South Africa. That's because locally, we've certainly had some interesting releases in the consumer space, both from an apparel and grocery perspective.
And Moe, there's some data in the US as well, so I'll let you kick us off then with the macro view, and I look forward to bringing you some of what we are seeing down in South Africa and just a few data points from recent releases.
Mohammed Nalla: Indeed, Ghost. I think we are actually expecting South African inflation data out later this week, based on the time of this recording. But what we're going to cover this week is a bit of a deeper dive in terms of US inflation.
We had that data released last week and it was quite interesting simply because it was a little bit softer than the market had anticipated. Certainly not as soft as the previous print in June, but the market's reaction was quite interesting because, it really is looking at this and it's saying, “Are we actually going to see softer inflation? Does this mean that the Fed actually keeps rates on hold?”
This all becomes very important as we head into Jackson Hole, which is occurring in about a week's time, close towards the end of this month.
So, let me jump into it.
The key point I want to actually raise is that, yes – US inflation has softened, but it's still running ahead of the Fed's 2% target (in fact, significantly more than that 2% target).
Now, the July print on a month-on-month basis was actually a positive 0.1%, which is quite tepid, in line with market expectations (maybe slightly below). But if you actually look at the previous print, the June print was down at a negative 0.4%, and that was the first monthly decline since 2020.
What’s actually driving some of this is obviously the fact that when you look at June and July, you did have oil prices actually coming off over that time period. So, that has certainly filtered through.
But when you compare that to inflation expectations, those are still baking in a resumption (or at least a continuation) of the Middle Eastern war. And so, on the back of that, they seem to be looking through some of this softness that we've seen in the recent inflation prints.
Another important point is that we don't just look at the consumer price index (CPI). We also had the producer price inflation (PPI) out in the US. And I would say this was the one that was maybe a little bit more important, because it was actually even softer than the CPI print in terms of perception and the market consensus. The consensus was actually expecting a positive 0.2%, and it came in softer than that.
Now, that means that, on a year-on-year basis, PPI in the US slowed from 5.5% to 4.7%. And I think the market was looking at that simply because it's higher up in the value chain, and that slowing down of producer inflation is expected to filter through in terms of consumer inflation and maybe even in terms of company margins as well. So, let's pay attention to that.
Now, Ghost, before I even move on from that, I mentioned what the key drivers were. Let's see what happened in the underlying moves.
Energy, certainly the big driver. Gasoline prices in July fell by 2.9% after falling 9.7% in June. That's the oil story I was telling you about. That’s also filtering through to that PPI number.
And then if we look at the more important stuff as well, in terms of non-discretionary, you're looking at food. That was only 0.1% on a month-on-month basis. Grocery prices actually fell by about 0.1% in the US. So, food, not necessarily a pressure point.
Shelter, that also only rose by 0.1%. And when you look at shelter, what's very interesting here and I actually want to raise it now, is that, when you look at hotel and motel prices, those actually fell 3.3%. Some of that's partly linked to this fading World Cup effect.
So that's going to have very interesting bearings in terms of a sector view and how you actually filter all of this information through in terms of stock prices and what's happening in that space.
Now, Ghost, I mentioned earlier on that this is all very important as we head into Jackson Hole. So, let's look at what the implications are for policymakers because at the last Fed meeting, there was still a lot of dissent. You had three policymakers on that Federal Open Market Committee (FOMC) actually favouring a hike.
Warsh has actually come out - he's been middle of the road. His history suggests that he's slightly more on the dovish side, but it's very hard to be dovish when inflation is running well above your target levels, so these kinds of inflation prints are going to be very important for Kevin Warsh as the Fed chair to try and resolve that dissent that he's seeing on his FOMC.
And I think after the recent data print, it certainly makes inflation look a lot less urgent of a problem. There are other important points here and trends to look at, and I'll touch on it as well – that’s the US labour market, which has looked a lot softer.
And so, with those data prints coming out, Kevin Warsh may actually have some sort of basis on which to try and win over those voices on his FOMC that are calling for a rate hike.
Now, wrapping up on labour, I think that's the other very important point. US labour data recently has been the most interesting thing because it's actually slowing. You're seeing that in the headline numbers. You're seeing that in terms of wage growth, which is actually slowing as well. And so that starts to filter through in terms of the overall expectation around the US consumer, inflation and the growth story.
Just touching on those July payroll numbers: non-farm payrolls fell by 23,000, and that was against the market's expectation for an 80,000-job gain! That was a big swing factor. That's certainly softening rate expectations more than the inflation number did.
And then, when you look at that, you're actually seeing that previous numbers (this is May and June) were also revised lower by 103,000 jobs. So, that softness in the labour market is concerning.
It's not collapsing – they're still adding jobs minus the most recent data print – but it is certainly losing momentum. And I think the Fed's going to pay attention to that, maybe making a case, keeping rates on hold for a little while longer.
I don't think the data is good enough to actually push them into cutting territory just yet. But this all becomes very important, because the US Fed sets the global price of money, and that inevitably filters through to emerging markets like South Africa.
The Finance Ghost: We’ve talked many times before about how the international monetary policy, and particularly in the US, obviously affects what happens down here. That's why we always keep an eye on it and we always bring it to our listeners, because you just can't actually operate in a place where you're not also keeping an eye on what's going on with the Fed and with the US market.
What’s obviously also important to think about is what the SARB will do around our own inflation. So, we talked about this on a recent show, Moe, and I know that you always keep a nice level head around, “What does the data actually say?”
You don't have the kind of emotional response to rate hikes that South Africans have, not least of all because you're not actually paying interest in South Africa anymore. Whereas people who are just trying to make ends meet and pay their bonds and everything else are never happy to see a rate hike. It really only rewards the savers in South Africa, and there aren't many of them. So, we'll see what happens with the SARB.
Mohammed Nalla: Yeah Ghost, I mean that's really very important when you look at South Africa. It’s very different to the US. I mean, you have inflation pressures in South Africa. You've seen inflation move up from around that 3% level closer to levels around 5% right now. And that's going to concern the SARB.
It’s around 4%, slightly higher in fact, and it's trending towards 5%. You've seen numbers above that when you're looking at producer price inflation. And so that actually explains the SARB's hawkishness around rates. They did hike rates around two meetings ago, then kept them on hold at the last meeting.
But that's just really important because, at the end of the day, the SARB is also concerned around perceptions, the global carry trade and protecting the value of the rand (not the rand specifically, but the value of the rand).
That is the reason I've certainly been a lot more partial to the SARB's more hawkish stance, because, at the end of the day, it's one of those institutional cornerstones that are just vital in terms of keeping South Africa – on a macro level – on the right track.
The Finance Ghost: Yeah. Let's look at some of the stuff that's come out on SENS recently. I'm not going to run through company-specific stuff here, but rather some of the themes that I'm seeing.
So, we've had a few retailers who have released results and obviously given updates to the market on what they're dealing with, from an inflation versus deflation perspective. We've touched on some of this stuff on the show. We've talked about some of the retailers recently.
We've also now started to see the food producers coming through. So, this includes, for example, the poultry businesses. And if you've ever followed any of these chicken companies, you will know that their earnings are entirely capable of literally doubling year-on-year because they have such thin margins.
What happens is you have a relatively small movement in gross margin and, by the time you reach the bottom of the income statement, that 20 or 30 or 40 basis points move at the top is actually extremely material to a company that has a low single-digit net profit margin or profit-before-tax margin.
So, inflation makes a big difference in those sorts of businesses. It also impacts what's going on in the clothing side and all kinds.
Let’s start with the clothing side, Moe. Inflation there is driven by manufacturing costs, things like cotton and other raw materials, and then shipping as well, because often this stuff moves across the world. It’s not manufactured close to the end consumer.
Obviously, food is quite different here because stuff needs to be fresh, and it’s difficult to move food across the world. People do it – we obviously export all kinds of fruit and that kind of thing to Europe – but clothing is certainly easier to have an international supply chain.
It’s a super competitive market. There’s loads of cross-shopping online and in-store. You’ve got SHEIN putting downward pressure on pricing. But the margins here for the clothing retailers actually tend to be more about getting the assortment right, rather than squeezing the last few rands out of their suppliers and trying to bring inflation down.
Because what really affects clothing results is the portion of full-price sales versus discounted sales. By the end of the season, when stuff is 50% off, you’re not making much money anymore. Certainly not versus the start of the season.
But in food, it’s a completely different story. Inflation at the top of that value chain does not always go down all the way through to consumers, because your retailers sit in the middle and they fight back against those food price increases as much as they can.
Obviously, they make a whole song and dance about it from a marketing perspective, as well, but it is the truth. They really do push their suppliers as hard as humanly possible.
At the top of the value chain, you'll find all kinds of input cost impacts on pricing. You've got energy costs, for example, when stuff is manufactured locally (as so much of it is). You've got labour disruptions – that's always a risk, especially in South Africa. You've got raw materials that range from maize through to meat. Beef, for example, has been a really contentious point in South Africa recently.
Then you've got other stuff that sits way out of their control, like the cost of tin. It sounds ridiculous, but the cost of tin has been driven higher by the AI boom. So, what's going on in AI is actually making those baked beans more expensive at the till, which is just an incredible thing to think about.
Obviously, the cost of plastic will play a role as well. Anything to do with packaging will make a difference.
So, you've got the food retailers who then sit and fight back against this, as I said. They try to keep the price increases as low as possible. And whoever wins that fight determines whether the food producers are having a good time or not.
If they can manage the inflationary pressures, if they can get the volumes through, if they can push some of it down to the retailers, then they can make a lot of money. But generally, their success depends a lot on achieving efficiencies in their business.
So, if I think of a company like Premier, for example, which is very bakery-focused, they've done really well on driving those efficiencies.
Then when you actually reach the food retailers, they focus on different things. For example, Boxer and Shoprite focus tremendously on price, whereas Woolworths is all about product differentiation above all else, with price in a reasonable range.
Success at Boxer is to drive volumes. And I think we talked about it on this show previously (I've certainly written about it in Ghost Mail in the broader ecosystem) - that Boxer's volumes growth was recently around 4%.
They had to overcome deflation to actually achieve a decent amount of growth. And the reason they had deflation is because their basket is so filled with staples (this means things like maize, rice), so there's only so much they can really do about that. You know, how much pressure can you really put on the supplier of the maize meal, for example?
So much of that product is literally just one basic input through an efficient manufacturing process and out the other side. It's very much a volumes game.
At somewhere like Woolworths or Checkers, product differentiation and convenience play a big role as well. We've obviously seen the growth at something like Checkers Sixty60 has been amazing. We know that Woolworths has great product differentiation, so there their inflation tends to be higher than what you'll find certainly at the likes of Boxer.
And Woolworths will typically have the highest price inflation because they care the most about product differentiation. You can't be all things to all people. You can't be highly differentiated and cheap.
And then you've got Pick n Pay and Spar stuck somewhere in the middle, which is why they tend to be struggling. So, you can actually see a completely different picture on inflation depending on which retailer you look at, depending on where you look in the value chain.
If you look at the chicken businesses, for example, that deflationary impact of the softs – so maize and all of that – is really helping them at the moment with their input costs. So, they are having a much better time at the moment. We've had good energy availability in South Africa. Bird flu has not really been a factor recently.
The likes of Boxer need to focus on volumes, and then the retailers stuck in the middle are struggling because they can't differentiate well enough, they also can't manage their prices low enough, and they're also not winning on convenience. So that's where Spar really feels like it's in the toughest Venn diagram right now. And we've just seen a change in the chairman at Spar announced literally this week.
So, still lots of stuff happening in the retail space, and that's really the bottom-up view from South Africa, Moe, of what we're seeing down here. A lot of it is narrative obviously, because you don't get huge breakdowns per category by the retailers, but you do at least get a sense of what's going on out there.
Mohammed Nalla: Ghost, that's very valuable because you've got to marry that bottom-up view to the top-down view as well, and see what some of the underlying trends are. I mean, I can't comment on clothing prices, but certainly one big risk flag out there that I am watching when it comes to softs as well, is that South Africa has been the beneficiary of, you know, effectively (pardon the pun) “soft” softs prices globally.
But it's more than that. It's actually the rand. The rand's been quite strong, certainly over the course of this year, and so that's provided a buffer to prices down in South Africa. If you see that trend continue, well and good. If not, it's going to come through with some pressure.
Then superimpose on that, if you look at global corn prices, global wheat prices, even soybeans (some of those are obviously direct input, some of those are obviously feedstock, so that then filters through to the chickens you mentioned and so forth) – those are all trading significantly higher than we had seen earlier this year. So, I would say pay attention to that food side of the equation because there are some risks there.
The softer inflation prints in the US were certainly helped by gas prices (or petrol prices, if you want to call it that) and a couple of other things, but the risks aren't gone just yet.
And that's the reason I'm not firmly in a camp of saying, “Hey, guess what? We're going to see rate cuts come through in the US.” I think if they actually keep rates on hold, that would be a decent outcome. And then let's see what happens with the war in the Middle East, obviously, that being the wild card.
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Until next week, same time, same place. Thanks and cheers.
