Keeping a wide view on the rand after all

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By Cees Bruggemans, Chief Economist of FNB.

Traditionally I have kept a wide (200 cent) view on the Rand’s one-year trading range (because that’s the kind of movement history has regularly shown) and an open mind on the outcome of crises. This past week both these traditions converged with a vengeance.

Barely had I opened the 2011 innings with the suggestion of a 100 cent Rand band (6-7:$ and 8-9:€) or events started steadily marching the other way.

Just goes to show that where currency volatility is concerned one should always think WIDE even if it makes planning and position-taking difficult if not impossible.

After having seen 6.55:$ in December, this morning the Rand is nearer 6.90:$. More significantly, after having seen 8.70:€ the Rand today is nearer 9.25:€.

Commodity currencies have experienced some setbacks, Aussie understandably following the floods and damage, but focus remains on China where last week they raised bank reserve requirements once again (after doing so six times last year), and where the next interest rate increase is apparently on the table.

Good Chinese growth data are expected shortly, and inflation will probably be higher than wanted this year. The growth performance should guide commodity prices, but if policy is tightened it may have the bigger sway.

One also notes the growing awareness of rising emerging market inflation potential, making their bonds less of a buy, something we have seen already for some months now.

So despite the liquidity engines in the US and Japan working overtime, other forces could be tempering their influence, inviting Rand pullbacks.

In the case of the Rand/Euro, this past week saw a lot more Euro-positive movement and the Rand weakening.


Europe’s political machinery is moving glacially in agreeing further institutional innovations, mostly reactive to crises rather than proactive to prevent them.

There are rumours about an eventual increase in the size of the peripheral lifeboat, finally able to receive more candidates (Portugal still seen as certain and rumours remaining about Spain and others).

There is talk of the lifeboat being allowed to buy peripheral debt in secondary markets. Such purchases of distressed debt at advantageous prices would be to the benefit of peripheral countries, while taking over the ECB role of addressing perceived mispricing.

There is talk of the lifeboat also being allowed to undertake capital injections (recapitalization) of banks (starting this overdue process, weaning such banks off ECB dependence, thereby also less overburdening the ECB).

And the price of lifeboat credit remains a debating point, with the current 300 points over Bunds considered too high (according to some, though not all, commentators for it supposedly still disallows Club Med sustainability).

This, though, will be the hardest nut to crack for it will decide the real level of Germanic subsidy transfers to Romanic peripherals.

Something far less strenuous than 300 points (but still risk-related) is apparently being aired, such as say 100 points over Bunds. This would allow Club Med sustainability, provided ironclad agreements are in place about Club Med fiscal austerity being sustained, and would not be ‘excessive’ favours demanded of Germanic taxpayers (or so say those who won’t be paying this subsidy).

Though only crisis stations seem to get European politicians to move on all these fronts, what is important is that it eventually happens. Though there remains a lot of noise in the ether, hints suggests there is movement on most of these fronts.

As in 2007-2008 in the US, one is reminded of Paul Gallico’s plot in “The Poseidon Adventure” where the few surviving desperadoes slowly, experimentally grope their way towards freedom and redemption, though never again being the same for having participated in the adventure.

Markets certainly have taken heart this past week, with good support for Portuguese and Spanish debt auctions. Together with speculation about coming lifeboat enhancements it put markets in the mood to lower the Club Med spreads over Bunds, in some case impressively so.

If that wasn’t enough, ECB President Trichet then saw the opportunity of sounding confident and hawkish, signaling that European headline inflation of 2.2% in December was outside the ECB target range. If this were to persist (note the qualification) he wouldn’t hesitate to start raising interest rates, and considered this entirely doable while continuing with providing liquidity support and where necessary buy debt assets.

It was enough for the market to look at the Euro with different eyes, both structurally and cyclically.

The worst might not after all happen and has been over-discounted in too many minds (though not shown up to the same extent in surveys) and the inflation bogey (commodity-led, as in so many other countries) has resurfaced, potentially changing the playing field.

As the Fed patently isn’t swayed by similar sentiments (it sees US resource slack keeping US core inflation nearer 0.5% for some time and considers the US recovery not advanced enough to worry about anything else), the Fed is likely to stick to its current stance of zero interest rates (potentially through 2012) and finishing QE2 (with presumably still an open mind as to what happens after mid-2011, though US growth momentum is showing encouraging firmness now, arguing against further actions, as many observers already convincingly do).

Thus we have another Macro Theme change. It is true that Trichet has already since 3Q2010 been speculating about an eventual change in ECB policy stance, but one always wonders in their case (this being Europe) to what extent that represents playing the political gallery, trying to gain leverage.

But this time the excuse (2.2% inflation) seems real, if European inflation really continues elevated. One cannot but note, though, that the comments came in a week when markets were taking heart about debt actions, and these ECB comments helped to boost the Euro at an important psychological moment.

For a minimal outlay (a few words spoken and eyebrows raised), market confidence was crucially reinforced, and the ability to keep the faith (in the Euro) strengthened.

One should not underestimate the ECB on this score.


The effect on us was electrifying, though, with our exporters in a very short space seeing the Rand back at 9.25:€ after that sinking feeling in December when 8:€ seemed to be coming into view shortly in the New Year.

These global tendencies had a still wider impact. Although gold had a few times breached $1400 in recent months, and platinum even re-conquered $1800, events of the past week reduced the near-term risk of global mayhem and did we see gold pull back (again).

Have we witnessed the reaching of the high water mark?

Certainly the short-term US prospects are for steady consolidation with the Fed in support (though longer term there remain many questions about US fiscal behaviour).

Chinese prospects aren’t necessarily unhealthy (high growth continuing) even as that country keeps tweaking its policy stance firmer (though also longer-term one may question its choice of policy preferences).

Emerging market space generally has kept policies accommodating while recovering from global recession, but with output gaps closed or closing fast, and commodity price surges further reinforcing inflation potential, a number of emerging countries may have to ‘normalise’ their interest rates a little faster this year.

But none of this is expected to derail the global boat. And though some people will keep muttering, the real risk of 2011 never resided in any of these, even if markets will adjust relative prices between regions.

The real risk of 2011 was perceived as Europe, and it only took the second week of the New Year to already gain some new Dutch courage as rumours swirled, politicians looked busy, sense seemed to prevail in the end (doesn’t it always in modern times?) and Trichet judged the moment opportune for a rapid beating of the drums, giving a ‘heads-up’ on the Euro. Not an ‘all clear’, mind you, but certainly a sliver of blue on the horizon of an otherwise still threatening leaden sky.

This tremor may be an important psychological change. In the Anglo-Saxon crisis we went through something similar in early 2009. No clear sailing thereafter, with double-dip questioning and other horrors still regularly trotted out, but in retrospect proving to be entering quieter sailing waters than 2007-2008 had been.

Despite momentous European actions still needed to be taken shortly on sovereign debt and Eurozone governance and its banks more thoroughly cleaned out over the coming year, at least the ship seems to be less pointed at a rocky coastline in stormy conditions and more towards open sea where it can weather things more comfortably.

On all these scores there could still be disappointment, causing sentiment to swerve unpredictably once again. But one senses, as in late 2008 in the US, that there seems to be movement in the right direction. And this counts.


What’s in it for us?

Global growth should continue more robust than some fear, with 5% mentioned by various sources. Our exports should continue to participate in that with our own shortcomings determining how much of a benefit we can garner here.

The fortunes of commodity prices may differ significantly with energy and agricultural prices in steep ascendancy. Precious metal prices may have less reason to expect further major gains, though the world remains fickle in its risk views, with longer trends yet to fully show.

For instance, has the last word been spoken about US monetary and financial conditions? Similarly, is the new Europe taking shape really viable? And will China still surprise us by losing its way?

Not in the short term, but on a longer leash?

There remain forces favouring Rand firming (US and Japanese liquidity especially), but others (Chinese actions, European comeback) may argue against this. Worldwide, bonds may be less supported (overvalued?) while equities may be doing more of the running.

That need not take the full shine off us, though the composition of forces may be changing. As bottom line this warrants the traditional wide (200 cent) view of the Rand rather than a narrow channel, as events can push our currency around at remarkable speed and in wide swings.

So I am back at 6-8:$ and 8-10:€ and want to see what next Macro Theme change the world wants to come up with, for good or bad.

On balance I remain positive global recovery, with the US proceeding steadily for now, Asia and associated emerging markets tweaking policy firmer and Europe regaining a better footing (though its play out will take years).

This may allow somewhat less unhealthy Rand overvaluation, but also allow less compensation for commodity inflation surges. What we gain through a better growth balance we may have to trade-off with a lesser inflation balance.

So for us these global changes may imply (still modest?) changes in composition. For now.

But the world is proceeding at a furious pace so be ready to modify our course shortly once again.

Source: Cees Bruggemans, FNB, January 18, 2011.

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