Traders love volatility. Investors hate it. And for sustained wealth creation, countries need to offer long-term investors the certainty they crave. South African political turbulence is reflected in the whip-sawing of its currency which has become the most volatile on earth. The environment might be stimulating to news junkies and delight money-trading desk jockeys, but it is really bad for the nation. Lack of certainty means no fresh investment or, worse, the exporting of capital. And this will continue until political stability returns. If you want to know how much misrule by the Zuma Administration, its promotion of crony capitalists and ridiculous bet on a BRICS bailout is costing South Africa, consider that last year the country’s capital outflow was a staggering R45bn. That’s a mountain of lost opportunity for a developing country whose economy needs to grow at over 5% to cut into rampant unemployment – but staggers along at less than the rate of its population growth. This is a recipe for disaster. There is no BRICS cavalry coming to the rescue. It’s time those cocooned in the Union Buildings absorbed this reality. Â – Alec Hogg
By Azar Jammine*
One suspects that there has been a sea change in global financial markets since the shock election of President-elect Donald Trump in the United States, the announcement of which came on 9th November.
Most of all, the suggestion made by Trump in his acceptance speech that he was intending to spend over $500m on infrastructural investment and possibly $1tn on such a programme, coupled with his intention to slash US corporate tax rates by 5%, contributed towards a belief that the benign and highly accommodative US monetary policy stance was about to reverse.
Markets figure that US public debt has already trebled in the past 30 years and will now be saddled by an even greater increase in such debt that can only really be unwound over time through inflationary policies which are bound to cause interest rates to soar. US long-term interest rates have rocketed in the past fortnight from around 1.6% on the 10-year Treasury bond, to 2.3% currently.
From South Africa’s perspective, the importance of this change in sentiment is that money has begun to flow out of emerging markets and other currencies into the Dollar to take advantage of the prospect of higher Dollar interest rates and improved (short-term) US economic growth.
True to form, the South African Rand has lived up to its reputation as the most volatile currency, weakening by more than any other currency (except the Mexican Peso on this occasion) when risk sentiment moves from “risk on”, to “risk off”.
From the end of May until the US presidential election, perceptions that US interest rates might rise only very gradually over the next few years encouraged a “risk on” environment, in which the Rand’s 18.2% appreciation easily outperformed that of every other significant currency.
Conversely, since the election of Trump as US president, the Rand has lost -8.4% in value, exceeded only by the Mexican Peso, which has depreciated by -10.0%. The Rand appears to have continued playing its role as the liquid currency that can act as a proxy for risk appetite or risk aversion towards emerging markets.
Fears Of Higher US Inflation Increased Likelihood Of US Rate Hike
In the past 24 hours specifically, the Rand has lost further ground as additional factors have joined the fray to ignite the fear of rising US interest rates. Risk aversion towards emerging markets has been exacerbated by confirmation by Fed Chairperson Janet Yellen that there is a high probability that US interest rates will rise “soon”.
The likelihood that the Fed Funds rate will be raised for the first time this year (and for only the second time in nine years) at the mid-December FOMC meeting, resulted in a renewed bout of strength in the Dollar and sell-off in emerging market currencies, including the Rand.
All currencies with the exception of Sterling, which in any case has been battered since the announcement of the Brexit vote in June, have lost ground since the election of Trump. It is just that the Rand has lost even more ground than all the other currencies except for the Peso. Furthermore, from a fundamental viewpoint, additional impetus for the expectation of US interest rates rising sooner and faster than previously anticipated has been provided by US inflation numbers.
The US CPI rose by 0.4% in October, exceeding expectations of a 0.3% increase. The 1.6% y-o-y US CPI inflation rate is now the highest for several years. Most importantly, excluding volatile food and energy prices, the so-called “core” US inflation rate rose to 2.1%, its highest level in a decade and a level which has exceeded the 2% inflation target of the Federal Reserve Board for the first time in so many years.
Together with reasonably favourable employment data and house price data in recent weeks, this makes for a cocktail of factors contributing towards the expectation of the Fed not only hiking rates next month, but also doing so more steeply than previously anticipated through next year and the year thereafter.
The Trump factor may have been the main catalyst for change in sentiment in this regard, but it has been followed by all these other fundamental inflationary fears based on statements and indicators.
The Rand Has Broken Out Of Dollar Down Trend
We had not been surprised by this weakness in the South African currency most recently. Over the past two months, we have been warning of the possible bottoming out of the Dollar vis-a-vis the Rand in line with a cyclical 30-week pattern from low point to low point evident over the past six years. This suggested that the Dollar was about to bottom out against the Rand during November.
The most recent weakness in the South African currency tends to reinforce the view that the R13.20-odd level to which the currency appreciated at the beginning of the month might have proved to be the high point for the Rand over the next few months. This has been followed by significant weakness.
Significantly, the downward trend of a 10-month downward channel of the Dollar vis-a-vis the Rand which has prevailed since January now appears to have been broken on the upside (for the Dollar). This presages further significant weakness for the Rand in the coming weeks and months.
There is one key resistance level remaining and that is the R14.71 low point reached for the South African currency at the end of August following the institution of fraud charges against Finance Minister Pravin Gordhan. Should that level be broken, one should not be surprised to see the Rand plummeting to levels of R16 or so over a fairly short period of time for technical reasons.
More fundamentally, the obvious factor which could bring about such weakness would be if the currency’s credit rating were downgraded over the next fortnight when the three main credit ratings agencies announce their decisions.
Also read: SA’s sideways economic slide makes downgrade ‘inevitable’
There is significant ambivalence currently about the likelihood of such a credit rating downgrade.
One’s biggest concern is that the ratings agencies have become disillusioned with the failure of South Africa to make the structural changes to its fundamental economic weaknesses required to lift economic growth in such a way as to enhance tax revenues and in this way help reduce the budget deficit and limit the escalation of the public debt.
There is no certainty that there will be a credit rating downgrade, but charts indicate we may be heading for such an outcome.
- Azar Jammine is the chief economist of Econometrix
