Rand prospects 2011

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By Cees Bruggemans, Chief Economist of FNB.

With a high inflation differential stacked against us (South Africa expects 4.5% inflation in 2011 as compared to 0.5%-1% core inflation in the US and Europe), you do expect forward interest rate differentials to be against us (they are) and for forward Rand expectations to show a weaker Rand (they do).

Meanwhile spot Rand reached 6.55:$ during thin summer trading, today still at 6.80:$, 8.78:€ and 10.55:₤. Yet there may be renewed firming ahead as the dynamics of recent years driving the Rand are yet to end.

Dollar weakness is driven by US forces, a combination of much resource slack, slow growth, repressed inflation and maximum policy aggression (fiscal and monetary).

Euro weakness is driven by European sovereign debt and banking scares and market anxieties.

Japanese policy aggression is driven by its own macro underperformance and the Dollar and Euro performances, inciting Japanese policymakers into defensive postures.

This is repeated in many (though not all) countries around the world.

To the extent that our own forex accumulation, lower interest rates, exchange control relaxation, any other new measures and widening current account deficit do not neutralize incoming excess capital, the Rand has further upward potential.

There is reason to be somewhat surprised on this score, for it isn’t as if nothing is being done or that underlying trends all favour ongoing Rand strength.

SARB continues to increase forex reserves, besides forex holding revaluations and swapping out corporate deal-related inflows.

The current account deficit reached a cyclically low 2.5% of GDP in 2Q2010, rose to 3% in 3Q2010 and probably kept rising in 4Q2010, with expectations for 2011 in 4%-5% territory as dividend outflows increase, with fixed investment-related imports doing the running from later this decade. These aren’t small changes.

Also, financial flow data in 2H2010 at times saw falloffs in foreign appetites regarding our bonds and equities.

So, where is the cyclical weakness in the Rand?

The Rand’s daily turnover is very large, with many transactions not even coming ashore here, taking place among proprietary trading desks abroad.

If this sounds remarkably like astronomy, where there isn’t enough visible ordinary matter to explain all gravitational behaviour observable in the universe, with astronomers resorting to concepts like ‘dark matter’ and ‘dark energy’ to balance the books (representing 95% of the total picture), this is not a mistaken perception.

Our visible daily financial flows may only be a part of the dynamic influencing the value of the Rand. With the world trading as it does, that makes for Dollar and Euro weakness, Asian defensiveness and apparently not enough countervailing power to prevent Rand firming.

With these global conditions in some respects still expected to deepen in intensity this year, thinking Europe, but also the US and not forgetting all of Asia, with precious metals yet to start losing their shine, our bond yields still reasonably attractive, and our equities embarked on a new earnings cycle, we should be prepared for more rather than less Rand strength.

For how long can this still go on?

The US has now been advertising for some time that the Fed will keep rates low for long (possibly through 2012).

The Fed is embarked on QE2 bond buying through mid-2011. If it stops then, it simply may be because fiscal stimuli are taking over the baton, with the same apparent Dollar downside effect.

It remains to be seen, though, whether the Fed will really stop with QE2 in mid-2011, with US resource slack so pervasive, its growth likely still modest (even if near 3%-3.5%) and there still being time in the political cycle for at least another eight months post-mid-2011 for some more bond banging.

Europe is facing many structural challenges, stretching at least through 2015. The ECB would like to become less accommodating, forcing governments to take greater responsibility for their indebtedness and their weaker banks. Even so, Europe’s complex challenges, low inflation and slow growth may well keep the ECB reasonably accommodative and the Euro weak. There may not be a Euro collapse, but there may not be a major revival yet either.

As to defensive Asians, many want to tighten policy but prevent ‘undue’ currency firming undermining trade competitiveness. That could stretch through 2012-2015.

Though the Rand’s trajectory won’t be straightline and bouts of European-induced risk averseness may intrude, causing Rand pullbacks, a firm Rand seems likely.

It may be advisable to at least plan for surviving 6:$ and 8:€ while hoping for breaks in the global weather making at times for less severe Rand strength.

Let the track record since 2002 guide you.

The world is going through a protracted phase favouring Rand strength, possibly lasting another year (or more), if crisis mode doesn’t resurface and our own policy actions prove limited.

After the crisis-induced Rand weakness of 2H2008, we are apparently in another multi-year stretch during which the Rand is overvalued for many producers and labour forces (manufacturers, farmers, some miners).

Great for consumers, though.

Source: Cees Bruggemans, FNB, January 10, 2011.

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