As always Cees Bruggemans throws up many talking points in his regular commentary, and below the Rand is in question. Not so much the Rand itself but rather what the Dollar movements will do to the curency. The Rand, is not alone however, as the Dollar has gained against all other currencies, off the back of lower commodity prices and the fears of a Grexit. The Dollar will also strengthen as the US Federal Reserve looks to hike interest rates later in the year. So as the small fish in the big sea, where does all this leave the Rand? Cees looks at two outcomes. A manageable Rand mangling over three years, but less so than what happened in the past four years. Or a potential 80% free-fall which sees the Rand at 22.50 to the dollar by mid-2018. Scary stuff for all involved. – Stuart Lowman
by Cees Bruggemans*
The rising Dollar reached on trade-weighted a 20-yr low four years ago (mid-2011), took three years to rise 6% (by mid-2014) and then rose by another 15% the past year.
It was “on your bike” for the Dollar heading north, with just about every other currency heading south, as global expectations (commodities taking que from China), Europe (taking its que from the ECB’s Draghi “believe me”), and the Fed (serial bond buying campaigns suggesting US economic revival) supported the Dollar, initially only weakly.
But Chinese and European (fear) reactions this past year (Greece, ECB, Shanghai) and especially steadily Fed progressing with bond “tapering” (2014) followed by mounting anticipation about Fed interest rate liftoff (2015) gave the Dollar turbo power.
Yet it can’t all be expectation, the real thing still has to happen, and when it does interest spreads will do the talking.
This makes a Fed liftoff in late 2015 and a ECB/BoJ delay (2016-2017) such a powerful combination as a game changer in global capital flows. America will become yield-favoured as its short-term rates rise.
It will not mean the end of global yield-seeking, but it will create a powerful attraction besides higher yielding riskier asset destinations. America will be getting back into the game even as Europe and Japan (large net savers and foreign investors both) linger in zero-rate territory.
It is all a long way of saying the obvious. Capital is going to favour America where for long this wasn’t the case. It means a stronger Dollar still, and by implication weaker currencies elsewhere.
The good news remains that this process is still gradual compared to some historic episodes, Volcker’s early 1980s especially, but also the average of the past five Dollar/Fed upswing cycles.
Even so, a lot of stuff may be discounted by now, fearful tantrums as markets are caught unaware mostly quite unnecessary, but that will not prevent exchange rates still adjusting further in coming years.
The Dollar will be honking, like your favourite geese in springtime. Get out of the way, I am coming through.
In 1982-1985 it meant a doubling in the Dollar’s value and a sinking of such strong currencies as the DM. But that was Volcker powered. This is supposed to move much more slowly, with rates not reaching for aggressive levels, as recuperation remains a reality everywhere.
Still, if you want to know where the Rand will be traveling the next three years, take our underlying inflation differential (about 4%, roughly) and add a Dollar appreciation factor (reflecting American strengths) and a Rand depreciation factor (do I dare call it SA IDIOsyncracies?).
In the first 7 months of 2015 the Rand weakened by 8,4% against the Dollar. Not as weak as Brazil and Turkey but much weaker than India
— kevin lings (@lingskevin) August 3, 2015
And what Rand decline rate do you get?
Not zero (Rand appreciating in real terms). Not -4% annually (Rand holding its own with Dollar in real terms) but more likely something in -6% to -10% territory.
At best (if -6% annually is such) that suggests a Rand of 13.25:$ in mid-2016, 14 in mid-2017 and 15 in mid-2018. It would mean a Rand depreciation of 20% over three years and a further real Rand depreciation of 6% by mid-2018 compared to our already undervalued condition today. That’s doable.
At worst (if -10% annually is such), it suggests 13.75:$ by mid-2016, 14.50 by mid-2017 and 16 by mid-2018 (for a Rand depreciation of 30% over three years and a further real Rand depreciation of 14% compared to today’s bombed Rand).
Still, having travelled from 7:$ in 2010 to 12.50:$ today (that’s nearly 80% in less than four years), these numbers aren’t particular intimidating, given what we know of a Dollar on steroids.
So are we underestimating the damage that the Dollar could wreck, and would we, in believing that, be underestimating the American (and global) recuperation powers from recent crises (far and near)?
Previous cycles saw outsized Dollar rises. This one will be no different, only more gradual, is the betting, given the global fundamentals and central banks behaving.
It still suggests a manageable Rand mangling over three years, but less so than what happened in the past four years. Is that for real?
Or are we looking at another 80% down by mid-2018 (Rand 22.50:$)?
Bear in mind the Rand was still supercycle overvalued in 2011 when this latest rerating began. Since then, our real trade-weighted Rand has gone through a long overdue adjustment, and becoming undervalued in the process.
That creates a shock buffer, as do our already wide bond spreads.
Still, the world may not be finished re-rating us, even if it isn’t in shock mode. The coming Fed liftoff will ensure another shift in relative yield attractiveness and that will affect capital flows and currency values. The Rand included. It has further depreciation to go as the Dollar has the cyclical advantage.
*Cees Bruggemans is consultant economist at Bruggemans & Associates