24 Jan 2018

Dollar continues to collapse, powering the rand to R11.85/USD

Annabel Bishop

Chief Economist

While the rand consolidates against the crosses awaiting further market positive news locally

  • The rand has continued its strengthening streak against the USD, running through the minor resistance level of R11.90/USD to R11.85/USD as the US dollar weakened further to 1.25 (1.246) EUR/USD, from 1.23 on Tuesday and 1.24 yesterday, before retracing somewhat.
  • US dollar weakness received support from the US team in Davos, as Treasury Secretary Mnuchin indicated that the dollar’s decline benefits US growth, while Commerce Secretary Ross added the US would intensify its efforts to protect its exporters. 
  • Worries over future US trade restrictions have also assisted in the greenback losing ground, as have concerns over government funding (temporary funding lasts until 8th February for the US government after its shut down on the past weekend and Monday).
  • The euro, in comparison, has been bolstered by investor sentiment in the zone, with consumers seen as optimistic and economic activity expected to accelerate this year, providing an impetuous to world growth. Additionally, markets are regarding political developments in Germany as positive.
  • The ECB is expected to attempt to talk down the strength in the euro, as it prepares for an interest rate hike. The ECB announces its interest rate decision today just before 3pm South African time, followed by Draghi’s comments at 3:30pm SA time. 
  • Markets expect any resulting euro weakness to likely be short-lived on the back of the US Davos team’s comments. However, analysis has shown the euro to be over bought, so some correction is flagged as possible - 1.246 EUR/USD is seen as a key resistance level.
  • The rand has reached R14.71/EUR this week, but then back tracked to R14.80/EUR today, while against the GBP it is R16.98/GBP, having strengthened to R16.71/GBP earlier in the week. The rand’s strength is particularly marked against the USD (due to US dollar weakness), which is seen as the headline exchange rate for SA, and is cheering market sentiment.
  • Positive global market sentiment and increasing optimism on SA’s economic outlook has seen the JSE reach news highs, of 61 704, and the retail and financial services sectors rallied, with the political situation in SA seen as improved. Lower levels of political uncertainty boost investor confidence. 
  • USD weakness boosts commodity prices, and as the rand is a commodity currency, this in turn supports rand strength. The resource sector on the JSE lifted somewhat yesterday, although rand strength does detract from the rand hedge stocks, so providing a limiting factor to JSE gains. 
  • Commodity prices, particularly metals have risen, with the economist commodity metal index showing them almost 20% higher than a year ago, versus the overall commodities index which is up only 0.8% y/y as food and non-agricultural prices continue to fall globally.
  • In South Africa higher commodity prices tend to feed through into inflation fairly quickly, but rand strength has a shielding effect. The PPI tends to take the brunt of the commodity price lift, coming out today at 5.2% y/y for December (November 5.1% y/y). Rand strength from mid-December should lower  PPI inflation in January and February 2018.
  • On a trade weighted basis the rand is only just above 3% stronger y/y given the weighting of the euro and GBP are higher in the basket than the USD. The MPC looks at the trade weighted rand in its inflation analysis, with headline inflation a y/y measurement.
  • PPI inflation could drop to 4.0% y/y this year, aiding CPI inflation in averaging 4.8% for 2018, but 2018 is not the SARB’s main inflation targeting period. PPI inflation could moderate briefly further, towards 3.0% y/y by year end if rand strength persists. PPI inflation tends to be more volatile than CPI inflation, reaching greater lows.
  • CPI inflation is generally expected to average around 4.5% in Q2.18, after troughing below 4.5% in Q1.18, and then exceed 5.0% y/y in H2.18, 2019 and 2020 on base effects, commodity price pressures and some improvement in domestic demand. 
  • The R186 has seen its yield drop to 8.28% on rand strength, with market expectations of an interest rate cut now growing for this year, as the FRAs (Forward Rate Agreements) factor in a 25bp cut. However, the rand strength against the USD on its own does not herald interest rate cuts.
  • The SARB targets inflation in six to twenty four months’ time when it makes its interest rate decisions, and the currency’s strength would need to be expected to be sustained by the MPC to such an extent that its inflation expectations drop to 4.5% for its inflation targeting period. This will be chiefly 2019 at  its March MPC meeting.
  • The next key resistance level for the rand (after minor resistance at R11.80/USD) is R11.70/USD (see “Rand pierces key R12.00/USD level, driven by USD weakness and ongoing positive sentiment towards SA aided by many leaders comments at Davos”, 23rd January 2018, website address below).
  • Risks for rand weakness remain, not least for the rand against the USD. The budget is scheduled for 21st February 2018, and will be watched by the rating agencies for both fiscal consolidation and the avoidance of excessive tax hikes that would strangle economic growth.
  • Moody’s, the last key agency which has SA on investment grade, is set to deliver a downgrade after the budget if fiscal consolidation is not met, particularly projected reduced expenditure and higher revenue, and lower borrowing projections. Sufficient progress on SOE governance reform is also key, and a faster economic outlook. 
  • SA could still lose its last key investment grade rating, even though improved governance led by Cyril Ramaphosa has made progress to avoid a downgrade. If SA drops down the rating ladder, the rand could weaken back towards R13.50/USD and beyond, with similar weakness against the crosses.