Rand strength ebbed fast

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By Cees Bruggemans, Chief Economist of FNB.

As fast as Rand strength seemed to be gathering the one moment, in December reaching 6.55:$ and 8.70:€, with increasing concern about yet more strength to come in 2011, so fast has it been ebbing away the next moment as January saw rapid Rand sliding taking hold.

If it had anything to do with us, it had apparently more to do with rumour than fact.

With some exasperation (at least it seemed that way), Governor Marcus mentioned at the MPC last week that the SARB had bought over $7bn in foreign reserves last year, and the Rand had persistently strengthened further (so what’s the use ………).

Yet in a matter of weeks in January, much of these Rand gains had been given up, with the Rand today trading at 7.06:$ and 9.60:€ (with 10:€ in sight shortly).

The only visible South African contribution were apparent rumours of yet greater currency intervention by the authorities, all supposedly to be revealed in the forthcoming Budget in late February.

Certainly such rumours, on the back of much similar actions by many other emerging countries, must have helped in unwinding some speculative Rand positions.

But mainly it seems to have been a function of changing US, Chinese and European fortunes and the way markets unceasingly adjust to such changes, real or perceived.

In the crescendo build-up of Rand strength late last year it were apparently US strength and European weakness that were doing most of the running.

But then after the New Year the US impact quietly faded, European fortunes changed (with some wonder) and Chinese preoccupation shone through, within weeks whipsawing the Rand from gathering strength to ebbing weakness.

These are powerful tides indeed.

———————-

Is there anything to the rumours about South African intentions of becoming yet more defensive, all to be revealed in the late February Budget? If so, why wait months rather than act decisively once you know what you are going to do?

Going by the body language of SARB Governor Marcus, the “New New” attempt probably won’t involve expensively buying yet more foreign reserves. Tried that, done that, zero return (except perhaps that the Rand could have been at 5:$ by now if nothing had been bought).

As to more capital controls (taxes and/or bank reserve requirements on incoming foreign capital flows or foreign transactions, as tried by scores of other countries), we seem to have a healthy sense of not interfering too much in markets (from past experience knowing what can go wrong). But that doesn’t mean somebody may not try.

There have been the exchange control relaxations of late last year, and presumably some more two-way traffic in the Rand. But does that remain pitiful compared to infinitely greater forces off the leash abroad?

———————–

My main focus remains with the big global players and how markets respond to changing fortunes, real or perceived.

The US made an aggressive move last August, announcing the intention of QE2 (more Fed bond buying), followed up by its reality from mid-November.

Initially this lowered long US bond yields and the Dollar, but from mid-November something changed.

US long bond yields started to RISE, further turbo-charged by the sudden Obama capitulation on taxes, with Republicans deciding to give a fight to the death over the Bush tax cuts a miss, and instead sharing the spoils of doing more and better for the American People …….

Instead of a fearful new contraction as these tax cuts were allowed to lapse, they were extended for two years plus additional stimulus being announced – more long-term unemployment benefits, $120bn in payroll taxes suspended for a year and more business investment incentive.

Roll out the barrel. Already brightening data prospects got a powerful kick in the pants from such proactivity, causing upward growth revisions for 2011-2012 all round, causing US bond yields to jump 1% (rather than slumping another 0.5% as QE2 had intended), with the Dollar starting to claw back some of that earlier weakness.

But as the Dollar started to normalize (heralding the high tide for the Rand), the Europeans finally showed some more vital leg to salivating markets.

Yes, we are talking, about expanding the size of the lifeboat (but we won’t), letting the lifeboat do fun things like buying back Greek debt and even make a debt restructuring unnecessary (but the Germans object) and lowering the official lifeboat spread so that Club Med countries can breathe as their debt trajectories finally become sustainable (though Germans still seeing purple on this, reflecting deep taxpayer sentiments).

But DESPITE all the sotto voice denials, the very fact there were talks about talks (an old ploy), hinted that all wasn’t mere innocence. A serious deal was in the making. And just as in the case of South African rumours, only on an infinitely larger canvass, markets were ready to buy on rumour, not least because it made an awful lot of sense, as such progress in belated steps had been seen before. There would be plenty of time to sell on the fact (though disappointment may not be as deep as suggested, for there could be REAL progress, except for diehard skeptics who question the very existence of Europe).

It was good enough to arrest Euro weakness at 1.29$:€. Instead of proceeding weaker towards 1.20$ (as rumoured late last year) the Euro staged a comeback towards 1.36$.

It was this that got the Rand impressively sliding against the Euro again.

With Euro talk at present good for 1.40$ in many overseas eyes as lifeboat announcements are expected through March that should underpin the European sovereign debt recovery story more comprehensively (most of the swirling January rumours proving true after all), the Rand has further potential to retreat all the way back to 10:€ shortly.

It would be a powerful signal that inherent Euro weakness is not going to persist, not in the presence of a roaring German economy advancing robustly AND sovereign debt issues become sorted more sensibly (with at the back of it all European banks quietly continuing with accelerated Club Med provisioning, with the new lifeboat here also assisting with bank capital, taking a burden off the ECB, and there even being talk of a separate bank rescue mechanism).

——————

But the missing middle piece of the puzzle, explaining much of the initial Rand pullback, had to be China.

China’s growth remains high (4Q2010 turned out to be over 12% annualized!), their banking liquidity overwhelming, their speculative juices (housing and equities) well developed, bank lending far too lively (especially off balance sheet, escaping the clutches of steeply higher reserve requirements), and inflation has jumped – mostly a temporary food bulge reaching 11% but even industrial price inflation topping 2% now.

Anyway, it made even the Chinese jumpy. With the Anglo-Saxon banking crisis behind us, and the European debt crises being addressed (not without a few helping Asian hands buying debt, a cheap way of showing solidarity and buying geopolitical influence, with those chips to be cashed when the time comes), the Chinese saw the sense of tightening up.

Last year, bank reserve requirements had been raised six times, by Christmas interest rates had been increased twice, the currency had been allowed to firm minimally and a lot of intimidating orders had been given to banks not to lend so much (to no apparent avail).

Increasingly, markets came to recognize that the Chinese would do yet more in 2011, including raising interest rates at least three (or more) times, and getting yet tougher with their banks. Last week, the leading four banks were given credit ceilings for 1Q2011 (implying considerable credit constraint). More importantly, those banks sinning liberally off balance sheet were told to bring assets back on balance sheet (where the higher reserve requirements can take its toll).

Much criticism remains, of the Chinese trying to ride this credit and bank liquidity tiger with increased controls instead of letting interest rates (and currency appreciation) to their job. The Wall Street Journal (6th January 2011) reminded China of Richard Nixon trying same in the US in the early 1970s (and not getting anywhere).

But these are higher sphere debates.

What mattered to commodity producers worldwide were the Chinese data and the policy willingness to intervene in the manner highlighted. It changed once again perceptions about growth and commodity prospects, probably too alarmingly, but that will get corrected by and by.

Meanwhile risk appetite pulled back, Aussie already being punished for its floods, but other countries also seeing market repositioning over China, probably none more so than the Rand.

As Chinese policy action is presumably still unfolding, the full market adjustment on this score could still take shape later this year.

Without saying anything derogatory about Chinese growth (9%-10%) and its inflation (4%-5%) this year, it probably all working out for them, we could still see some more headwinds for commodities and the Rand from this source.

So between improving US prospects, less scary European prospects, more decisive Chinese prospects and South African intervention rumours, the Rand’s prospects have (again) abruptly shifted in a matter of weeks.

Instead of aiming for 6:$ and 8:€, we are back above 7:$ and hopefully good for 10:€ shortly, greatly easing the growing sense of emergency for our exporters and their labour forces so clearly deepening in 4Q2010.

But whether this alignment of prospects will linger for any length of time, keeping the Rand trajectory steadier than seen recently, remains to be seen.

For myself, I would describe brightening US prospects real (so that may not warrant bouts of renewed Dollar weakness), European structural progress real if snail-like and Germanic growth strength very real (so that may not warrant too much Euro weakness) and Chinese policy ramping probably temporary (as its growth and inflation play out benignly, though take note of the Wall Street Journal’s history lessons and sniping) and in the process capping commodity currency pullbacks.

All that could balance out nicely, primarily in 7-8:$ and 10-11:€ territory for the Rand.

But as recent weeks showed, a 100 cent trading band for the Rand seems far too narrow to accommodate all the forces on the loose here. A much wider band (200 cents?) seems appropriate.

The Rand is bound to be very volatile trading-wise (even if its trajectory is again somewhat more stable, possibly not unlike 1H2010).

Source: Cees Bruggemans, FNB, January 24, 2011.

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