The Rand’s long and winding road

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By Cees Bruggemans

For over six years now, counting from mid-2002, the Rand has been 95% of the time in 6-8:$ territory. Can that kind of stability continue indefinitely?

Not really, finding ourselves today at 7.80-8.00:$, with a likely persistent current account deficit of 7%-8% of GDP (much closer to Kiwi’s 8% than Aussie’s 5.5%). And a lingering inflation differential with the US of 3% when normalized for the funny business of the past year in which that toxic commodity shock took us on horns and StatsSA was late in changing weights.

So the next six years is much more likely to see the Rand 95% of the time in 7.50-9.50:$ territory, everything else remaining the same.

Of course the next six years could play quite differently from the previous six years. This time we start with a huge deficit rather than a surplus on the external accounts. And the remarkable sweetness of benign global conditions of 2002-2007 looks far gone when seen from this juncture.

But then we must perhaps reverse the shape of things. That last six year period started sweet and ended in cow dung, while the next six years start off in pig mud and could end all sweetly, at least for a while.

Unlikely? Why?

The US has had to absorb some serious financial dislocations these past two years, and will be doing so for one or two years more. But after that the debris will have been cleared, and the US ready for action again, from a reconfigured banking base with a lot of recessionary slack in its economy and labour force (unemployment over 6.5% next year), meaning good recovery potential for some years.

Meanwhile, the Asian growth locomotive will have ended its slowdown, allowing global commodity capacity a breather and enough room to catch up. The inflation bulge of the moment will have been leveled, and interest rate regimes should be less defensive.

With global growth taking off anew, there should be no shortage of global liquidity or risk appetite, which will matter most to us in funding our external requirements.

This time, though, even excessive capital inflows will be more easily absorbed by us than a few years ago. Therefore presumably less danger of the Rand overheating (going back below 7:$).

As to blowing out the other way, beyond 10:$, there remains such risk, especially in the short-term on the back of new US financial disturbances, longer term on the back of local political policy mistakes, and at any time because of some Black Swan moment nobody saw coming.

So downside risk will always be with us. But as predicting event risk is nearly never successful, a true mugs game, one makes it a qualifying footnote, though an important one, given our history.

Besides these big themes (US and Asia reviving and we again piggybacking on their recovering fortunes beyond 2009), there are a few more global footnotes to take into account.

In a Rand-positive sense it seems we have finally been discovered by Japanese retail investors seeking exotic destinations. I have written wistfully about this before in years gone by, but it seems now our ship is finally coming into port. Whether it will ever get as bad as Kiwi experienced in recent years, time will tell.

A recent Wall Street Journal article speculated whether Japanese small investors’ voracious appetite for higher returns could be a boon for the high-yielding currencies of South Africa, Turkey and Brazil.

It seems it is about time to say thank you for what we are about to receive. With Japanese funding costs 0.5%, and the Rand undervalued near 8:$, with high interest yields of up to 12% and therefore half as high as Kiwi (but with the same current account deficit, but a higher growth rate), is it a wonder we are finally getting to be on the map?

With the Kiwi and Aussie economies turning down, but more importantly this creating room for interest rate cutting over there and this in turn pushing their currencies lower, Japanese investors seem to be interested in widening their horizons.

South Africa also has a weakening economy, but a staunchly defensive high interest rate policy, at least for now, into the bargain maintaining some kind of floor under the Rand. As Kiwi will tell you, going by previous experience, that draws Japanese like bees to honey.

The vehicle of choice is Uridashi bonds. These are non-yen (Rand) denominated bonds issued offshore and sold to Japanese retail investors.

It presumably says something that turnover in Rand at Japanese margin-trade brokers has shot up this year. The Rand has apparently overtaken the Dollar this year as the third most popular currency, following Kiwi and Aussie.

It seems we have arrived. There is the suggestion of strong tailwinds for the Rand against the Yen (and therefore everything else) in the longer term.

As Japanese retail investors apparently tend to go after absolute returns instead of expected risk-adjusted returns, they are often willing to stomach hefty foreign-exchange risks in their hunt for yield.

It may sound like cordless bungee-jumping to us, but who are we to argue with a little excitement in otherwise drab 0.5% lives?

Risk-takers buying the Rand seem to believe the 12% yield makes up for the higher Rand risk. If traders keep Rand-denominated bonds for two years, they can tolerate 24% changes in exchange rates.

Still cordless, I would say, going by some of our history, within the 6-8:$ band, and especially outside it, but who are we to argue.

The Kiwi central bank governor and Minister of Finance in recent years pointed out the collective madness of punting the Kiwi with its unpromising fundamentals (they of course wishing their currency weaker).

But Uridashi enthusiasts kept on pumping it higher, in the process simply reaping yet more gain. In numbers there is great advantage to be had, at least for a while.

It is becoming easier for Japanese retail investors to invest in a broader range of currencies. Information about South Africa and Rand liquidity have both increased sharply from a year earlier as most major Japanese banks now handle the unit. The Rand has only recently become popular among long-term-focused players.

But there is also Rand-negative news out there. Going by the SARB’s body language, the US financial workout offers the greatest reason for concern, if something untoward should blow, and global risk appetite were to be deeply disturbed.

But there are other concerns, too. The European economy is sliding into recession, with 2Q2008 already negative at -0.2% and more sliding expected in coming quarters. As Europe is still our biggest trading partner, this isn’t good news for our export potential, and our trade deficit prospects.

But how can the US still be cruising along at 3.3% annualized growth, while Europe is dipping into recession despite it having had lesser travails so far?

According to another Wall Street Journal report, the reason has to be sought in contrasting policy stances. The Americans have been proactive, giving fiscal injection, cutting interest rates jarringly to the bone, and getting an undervalued Dollar in return.

All of that has kept US consumers ticking over despite horrendous housing and credit headwinds, while US exports are enormously strong.

In Europe, however, they pride themselves on interest rates double US levels, with a strong Euro to boot, and no scope for fiscal action. Hello, hello, hello!

Weighed down by the global housing downturn, the financial crisis, the commodity price shock eroding real purchasing power and the tightening of monetary policy, the euro-area economy is succumbing to recession.

The recession may not be very deep, but economic weakness could be protracted and eventual recovery fairly sluggish, given the housing and credit problems.

US resilience as ever seems a matter of greater economic flexibility and more proactive use of macroeconomic policy as compared to European realities and responses.

Europe in the caboose, the US vigorous if middle aged, with impatient Asia in the lead. These are some of the external economic and financial influences shaping our Rand’s long and winding road.

References:

Takashi Mochizuki, “Real, rand draw interest from Japanese investors”, Wall Street Journal 18 August 2008

Thomas Mayer, “Europe’s Hangover”, Wall Street Journal 24 August 2008

Source: Cees Bruggemans, FNB, September 9, 2008.

 

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