Get used to the ‘stronger for longer’ rand
I’ve attended countless economic presentations this year. At these events South Africa’s top economists have shared their views for the local currency. It seems – as we enter Q2 2011 – the rand will remain “stronger for longer”. Economics is all about cause and effect. We worry about rand strength because of its impact on the global price competitiveness of local manufacturers and producers. And of course we worry about the knock-on effect of rand devaluation on local prices, and inflation. You know the story – rising inflation – Reserve Bank responds – higher interest rate!
But a strong rand has benefits too! As I pen this newsletter Brent Crude oil is changing hands at $124 per barrel… That’s $80 per barrel more than we paid through the recent recession – and we’re feeling the ‘pinch’ as fuel and diesel prices go through the roof. These price hikes will slowly filter through the economy, sending inflation through the Reserve Bank’s 6% upper inflation target. The rand at R7.00/$ or better is acting as a buffer to this high oil price – and a valuable ‘insurance’ against runaway inflation
Will the strong rand trend reverse?
To find out more about prospects for the local currency we attended an economic outlook presentation by Johann Els, Senior Economist at Old Mutual Investment Group South Africa (OMIGSA). He prefers using the nominal trade weighted rand index to illustrate local currency trends. An assessment of the rand’s performance against a basket comprising the US dollar, Euro, British pound, Yen and Renminbi proves telling. The currency has continued its 2009 strengthening trend through 2010 and the first part of 2011. “Our forecast is for a moderate weakening of the currency; but we cannot rule out further rand strength in the short-term,” says Els.
Going back four years the rand has only bucked the strengthening trend due to political risk (after the African National Congress’ Polokwane Conference and Eskom’s rolling blackouts) and the sub-prime crisis! We also saw a brief hiccup earlier this year when it emerged the US recovery was slower than expected. But this trend introduces another economic conundrum… A strong rand is both good and bad for the economy. It contributes to lower inflation (good), lower interest rates (consumers love this) and the slower than expected economic recovery (bad).
Reasons to be optimistic
Why is the rand so strong? We can talk endlessly about foreign investor capital inflows to our equity and bond markets… Els explains: South Africa’s economic growth may take some time to reach the levels experienced between 2004 and 2007; but our fiscal position is a great deal better than many economies worldwide, which means foreign investors receive greater relative returns.
When all is said and done the rand is strong for two reasons… First – we are a commodity economy. Commodity prices have been extremely strong over the past 12 to 18 months, and will remain so because the US Federal Reserve cannot afford to hike interest rates. And second we belong to the emerging market ‘bloc’. “Despite somewhat slower growth in emerging economies this year, on a structural basis China is still expected to grow at a rate three times that of the USA – and that means emerging markets are still very much in play,” says Els.
A weak dollar is considered good for commodity prices – so the strong rand / high commodity dance will probably continue for some time! “We have a healthy economy – strong commodity prices – the current account balance looks good – and we offer offshore investors decent relative returns… Why would the currency collapse?” he asks. “Yes, over the medium to longer term there are reasons why the rand should weaken – rising international interest rates – interest rate differentials narrowing –foreigners holding plenty of SA Assets etc… But for now things are looking good.”
On the rand and interest rates
We’ve established a strong case for the rand to remain “stronger for longer”. And we can strengthen our case further when we consider the outlook for global interest rates. In the short term global interest rates are not going to be aggressively hiked… which means the foreign investors propping up our currency won’t suffer from sudden risk aversion. They’re getting decent yield in South Africa. Our rates are already high – and the next move is likely to be higher!
“Inflation is now in an upward trend, but we expect it to peak below the top end of the forecast range,” says Els. OMIGSA believes the Reserve Bank will think carefully before hiking local interest rates. The bank knows there are problems with the credit cycle, that consumers remain in distress and that growth is not as strong as in previous cycles… Which means the first interest rate hike could be delayed until early 2012!
Editor’s thoughts: Different economists – different interest rate expectation! Although the economists agree interest rates are going up, they cannot agree on a time frame… It looks like the earliest the bank will ‘move’ is in September 2011… But if they pay close attention to the warning signs they’ll probably delay into the New Year. Do you expect a more cautious interest rate hiking policy under new Reserve Bank governor Gill Marcus? Please add your comment below, or send it to [email protected]
