US inflation is a worry; we are directly affected – TreasuryONE’s Andre Cilliers

Last week, the US was in a state of panic after it was announced that the inflation rate might start rising quite rapidly. Stock markets were down sharply on Friday as a consequence – but what is that doing to our currency markets? In this week’s Currency Focus, TreasuryONE currency strategist Andre Cilliers joined Alec Hogg and the BizNews Power Hour team to let us in on what the US inflation means for the rand and offshore investments.

Andre Cilliers on what US inflation means for currency markets: 

Well, that’s an interesting one and I spoke to somebody last week and I joked and said the Federal Reserve continuously speaks about inflation that’s in transit, and I said my concern is when it starts applying for political asylum. That will be the problem. And I think what they now admitted is that there might be an application for that and that there might be a need to adjust monetary policy a little bit sooner and at a slightly steeper rate. Now, if we go back to what they had said before, they said 2024 and that would be one increase, and now they’re saying 2023 and most probably two increases.

On why American interest rates affect us: 

Well, markets are always forward looking, and we should be bothered about what happens in America for the simple reason that that could create an exodus of money from emerging markets back into the Americas. So that flow of money could negatively influence the way in which people invest money into our bond markets as such. So that’s why we have to observe it. [It’s] also very important to watch America because it is the biggest economy in the world and they determine kind of what happens in growth for the rest of the world.

That is why we are seeing this massive reaction since last week. So it’s not really a weakening of the rand at this point in time that we have to speak about. We have to speak about the strength of the dollar. If you look at the dollar, then the dollar index was hovering just above the 90 levels. That’s back up at the 91 and a half levels, and we just have to simply look at the euro and see that that was trading close to the 123 levels not so long ago and that’s down to 118. The lowest it went was around 118.50. It’s slightly higher today. So dollar strength caused the weakness and the run on the currencies. And obviously, when you have these things, you go through certain technical levels and that creates orders that get triggered. People buying dollars because it simply went through certain technical levels, people cutting positions that they might have had where they were long of rands [and] short of dollars, and then they get out of acquisitions and that’s what we have seen last week.

On the impact of interest rates rising sooner than previously anticipated:

It could have quite a bit of an impact but the important one is if you look at our central bank, the South African Reserve Bank has always been forward looking, also looking at our inflation figures. Our inflation figures are also picking up and the Reserve Bank has always been on the forefront and a little bit ahead of the curve. So this simply says to us that there’s also a possibility on our side that we might see interest rate increases slightly faster and in a shorter time period than what was anticipated. Over time, these things do actually correct. So at this point in time, the concern is about the American rates, but we have to start watching what happens in other central banks and what they alert us to in terms of what could be expected from them and changes or possible changes in their monetary policy, including South Africa. So for the very, very short term, we have the strength that that might very well correct over a period of time as we hear what other central banks have to say in terms of their monetary policy.

There’s another big change that occurred. Not only what happens in 2023 and what happens with short term rates by the Federal Reserve, but they are currently quite actively busy in the markets with what you call reverse repo trades. Now, that’s draining liquidity out of the short term market and it actually raised that rate by five basis points. Now, five basis points – 0.5% sounds very miniscule, but it’s significant in the sense that it was at zero. So banks can now actually take surplus cash and go and invest it with the Federal Reserve through the reverse repo market at five basis points. That means that the liquidity gets drained out of the market – money that could have been lended out to retail customers, to corporates alike, which at this point in time also tells me that there’s very little demand for credit and banks are sitting with surplus cash rather than investing it with the Federal Reserve. And that is also one of the massive reasons why we’ve seen this big move last week of a dollar strengthening to these levels where it currently sits. We can expect the Federal Reserve to continue with that and that’s a very, very clear indication of what they think can happen to short term interest rates and the draining of liquidity.

What it means for South African importers and exporters:

Well, we’ve had exporters that were very, very concerned at the R13.50, R13.60 levels because that was dramatically impacting (negatively) on their profitability. We [are] now at these levels where we are now – R14.25, R14.30 – and that’s good levels, taking everything into consideration, taking into account that fundamentals in South Africa had not changed, taking into account that we will still expect relatively good growth for this year. We still expect an inflow into our bond market. Our interest rates are still attractive to foreign investors at this point in time. So taking all those fundamentals into account, exporters should actually now go into the markets and look at what products they can take to hedge themselves against any further strengthening of the rand back down to R13.60 or R13.70 levels.

Importers, well, we recommended already that at those lowest levels they should be buying dollars and protect themselves. They should continue doing that and make sure that they don’t get negatively influenced by any further jump or weakness in the currency, especially in the short term. I would still be kind of fairly happy not to take long term cover as an importer, but as an exporter, I would like to see them coming into the market and actually covering themselves and taking out hedging programs to look at protecting themselves.

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