Opposites attract?

John Loos, senior economist at Absa, says that it is expected that the realignment of the major currencies of the world will continue to have a great bearing on the fortunes of the rand, with the local trade-weighted currency moving inversely to the direc

The dollar rallied from late-December until early-February, but appears to have resumed its primary trend of weakening.

Statements in recent times by the Fed appeared to have been supportive of the dollar during its rally.

Chairman Greenspan suggested that the depreciation of the dollar should assist in reducing the trade deficit, while all indications are that the Fed is likely to continue raising interest rates at a “measured pace”, and indeed there was a further 25 basis point hike in the Fed Funds Target Rate in February to 2,5%.

The Bush Administration has also been making statements that are dollar supportive in the form of pledges to reduce the Federal fiscal deficit.

While the US December trade balance did improve slightly from USD59,3bn in November to USD56,4, one month of improvement is insignificant in identifying the beginning of an improving trade balance.

Certainly it would not appear that economists analysing the US economy have much confidence in the possibility of an improving current account deficit in either 2005 of 2006 at current levels of US dollar.

Unlike the consensus view, We take the view that the dollar will not be able to hold its ground should the current account deteriorate further, and therefore take the view that the greenback will trend towards the weaker side of the consensus forecast.

Our forecast EURUSD rate remains one of moving toward USD1,40 per euro on the second half of the year, and thereafter some stabilisation around that level due to a more visible current account deficit improvement in 2006 than what the consensus is depicting.

For the rand, this would mean further strengthening against the dollar. While some may raise the issue of narrowing inflation differentials between SA and the US, the counter argument is that significant further narrowing is already “in the price”.

Furthermore, growth differentials must also be seen to be playing a role, and in 2005 SA is forecast to grow slightly faster than the US (4% vs a US forecast rate of 3,5%), compared with a slower growth rate in 2004 (3,7% for SA vs 4,4% for the US).

We thus expect the rand to move to below the USDZAR5,50 mark in the second half of the year, whereafter a mild weakening may come about going into 2006 on the back of more concrete signs of an improving deficit situation in the US, as opposed to mere talk of possible improvements.