Financial markets have still not factored in another interest rate hike this year however, with the Fed’s hawkish tone seen to be aimed at limiting market (and consumer) exuberance on a perceived end to the rate hikes.     

The Fed noted that it still remained “highly attentive to inflation risks”, and that economic activity is running at a “solid pace”, while jobs gains, despite some moderation in pace, were still “strong”.

Specifically, the Fed said that the decision to keep interest rates on hold did not necessarily mean that US monetary policy had become sufficiently restrictive enough to contain inflation yet, which has kept uncertainty elevated.

The rand, which had strengthened to R18.68/USD, R19.86/EUR and R22.88/GBP after the FOMC meeting, subsequently has seen some retreat, to R19.04/USD, R20.17/EUR and R23.18/GBP today as the FOMC comments are digested.

That is, initially markets were cheered by the Fed’s decision to keep interest rates on hold, but subsequently has weakened on deeper readings of the Fed commentary, with signals also of a delay in US interest rate cuts next year. 

Some slowing in US economic activity was recorded in the last few days, and US dollar strength is a key driver of the rand’s weakness today, as markets remain very jumpy on any signs of US economic weakness.

Looking forward, this week sees a slew of US economic data, which will give further insight into the state of the US economy, along with the core PCE deflator reading, expected lower at 3.9% y/y for August (4.2% y/y prior), making markets jumpy.

The message of higher interest rates for longer from the group of Central Bank meetings last week has dulled market sentiment this week, increasing risk aversion, and so benefiting the US dollar.

South Africa’s Central Bank Governor, Lesetja Kganyago, warned at SA’s MPC meeting last week that “(t)he job of tackling inflation is not yet done”. “Risks remain. Should we see them materialize, we stand ready to act.” 

“There is no virtue in high inflation,” Governor Kganyago added. “High inflation begets high interest rates and the cries of South Africans over the years has been that inflation is eroding our incomes.”

However, markets worry about SA’s weak economic growth rate, likely only around 0.5% y/y this year, which will worsen on higher interest rates, as will next year’s economic outlook on a delay in cutting interest rates. 

While hawkish Central Bank tones are aimed at quelling inflation, worries are that failing to wait for the lagged effects of two to three quarters, and up to two years eventually for all effects, to feed through could “torpedo economies”.

An EU Central Banker further warns "we consider that our key ECB interest rates have reached levels that, maintained for a sufficiently long duration, are broadly consistent with the timely return (of) inflation to our target".

French central bank governor, Francois Villeroy de Galhau, further adds that  policymakers "now know with growing confidence that we are on the right track" on the road to returning inflation to the 2% target by 2025.

The EU’s largest economy, Germany, saw business sentiment fall for the fifth month in a row in September, with the Ifo institute elaborating that "(t)he German economy is treading water," and that a third-quarter contraction was likely.

Additionally, world trade volumes fell at the quickest annual pace since August 2020 the latest World Trade Monitor showed, while sentiment indicators further suggested that global trade would remain fragile in the coming months.

Worries over economic weakness globally, and the risk of overly hawkish Central Banks proving too restrictive on monetary policy, has caused risk-off in global financial markets, adding to the domestic currency’s softness this week. 

The rand trod water against the US dollar last week, as markets continued to worry about the deterioration in SA state finances from overspending in a weak economy, although some good news came out from better than expected data in China. 

That is, the world’s second largest economy saw better than expected retail sales and industrial production data last week Thursday, as stimulus measures started to take effect, boosting market optimism.

China’s industrial production rose by 4.5% y/y, versus expectations of 3.9% y/y for August (versus 3.7% y/y previously), while retail sales came out at 4.6%, also for August (expected 3.0% y/y, previous 2.5% y/y).

Concerns still centre around China’s real estate market, as new home sales saw a further contraction m/m in larger cities, as developer defaults remained a key concern and fixed investment growth, at 3.2% y/y, was below the expected 3.3% y/y.

However, the markets took the industrial production and retail sales data as showing a potential brighter outlook than has been feared, as concerns had been building on the ineffectiveness of China’s stimulus measures to date.

The rand reached R18.73/USD, R20.15/EUR and R23.44/GBP last week, as some worries over a global recession eased. Additionally, the more important of the US CPI inflation (core) for August came in in line with expectations, supporting the rand. 

US CPI inflation did come out higher than expected, at 3.7% y/y versus 3.6% y/y, and 3.2% y/y previously, but the core CPI (excluding food and energy) inflation rate was in line with expectations, at 4.3% y/y, down from 4.7% y/y, which helped sentiment.

Looking forward, this week sees the US and SA’s Central Banks meet on their respective interest rate decisions, with the US still expected to see the Fed leave US interest rates unchanged this week, and cut interest rates in 2024.

A more dovish Fed than expected would likely cause some US dollar weakness and so rand strength against the US dollar, with the opposite on a more hawkish US monetary policy tone, while SA’s MPC is also expected to keep rates unchanged.

The rand lost ground last week as domestically markets worried about SA’s deteriorating outlook for its government finances, with electioneering heating up but concerns that spending promises will imperil the country’s fiscal health. 

The hefty R143.8bn fiscal deficit recorded in July has sounded alarm bells, with the markets digesting the figure over the past week, and the rand had weakened to R19.75/USD by Thursday, although US and Chinese data also caused some jitters.

Last week Wednesday saw robust US ISM employment figures, at 54.7, versus 50.7 previously, adding to worries about the strength of the US labour market, with the Fed having indicated US labour market weakness is necessary for lower inflation.

The ISM prices paid data in the US on Wednesday also came out higher than expected, at 58.9 versus 56.8 previously, adding to concerns over the stickiness of US inflation, particularly from the production side.

In addition, unit labour costs came out at 2.2% in the second quarter, higher than the 1.6% previously, and the 1.9% expected, adding to the general sensitivity about still elevated inflation measures in the US compared to recent years.

Earlier in the week PMIs weakened in China, while China also commented on the risk of  "a new Cold War”. "Disagreements and disputes may arise between countries due to misperceptions, diverging interests or external interferences".  

China’s premier added, in order "to keep differences under control, what is essential now is to oppose picking sides, to oppose bloc confrontation and to oppose a new Cold War", with the comments coming at meetings in SE Asia with the US.

Specifically, ASEAN (the Association of Southeast Asian Nations -  a political and economic union of 10 member states in Southeast Asia) held separate summits with China, Japan, South Korea, the United States and Canada.

The economic slowdown in China, concerns over inflation in the US, and the increase in political noise in SA ahead of the 2024 elections, while SA’s state finances are seeing market deterioration, all added to rand weakness recently.

The global economy has seen its economic growth rate slow, and trade conditions have become defragmented, while geopolitical risks have resulted in Western countries wishing to diversify away from heavy trade dependence on China.

A strengthening of trade ties with the United States and India has occurred in contrast as India is seen to share similar demographic values as Western nations, and signed a number of free trade deals to boost industrial production and exports.

Russia's trade has slumped with the West in turn. Focus is now on the BRICs, with the summit taking place this week in SA. The BRICS is a trade and investment grouping, but SA is not in a trade surplus with the combined other members.  

The BRICS make up about a quarter of the global economy overall, and  around a fifth of global trade with the grouping seeking to strengthen trade ties with each other, as well as  increasing investment, and so aiding economic growth.

The group is also seeking to regularly use local member currencies to trade amongst each other. A common payment system has been suggested, but it would most likely take several years to put all the systems in place.  

Furthermore, the SA Reserve Bank recently said it has not had any involvement in developing a BRICS common currency. A deepening use of local member currencies for trade is expected to be the main outcome in this regard in the foreseeable future.   

The BRICS summit will also discuss possibly expanding membership to include other countries. President Ramaphosa highlights  "we have resisted pressure to align ourselves with any one of the global powers or with influential blocs of nations”.

“Multilateralism is being replaced by the actions of different power blocs, all of which we trade with, invest with, and whose technology we use." The rand is likely to remain undermined by concerns over global growth.

The South African rand has fluctuated widely against the US dollar in recent weeks, strengthening towards R17.00/USD in July before running towards R19.00/USD in August. This volatility is in line with the traditional thin trading period during the northern hemisphere summer vacation month, when many market players are on holiday and risk-taking is typically dulled. 

During this period, markets tend to be more risk-averse, with both positive and negative events having an exacerbated effect on financial indicators and market reactions to events being more pronounced. The rand has also seen volatility against key crosses, although to a lesser extent, swinging from R22.87/GBP to R24.29/GBP and R19.87/EUR to R20.94/EUR.

The S&P Global Investment Manager Index for August highlights heightened risk aversion, with increased bearishness recorded across both risk appetite and expected return gauges. The expected equity market performance gauge has declined to the lowest level since May, reflecting a heightening of bearish sentiment. Despite more muted concerns about a US recession, US equity investors are still seeing prices being elevated.

This follows a more optimistic period for investor sentiment in the last third of July, which markets likely overshot, leading to some correction in August. But fundamental market concerns also run deeper, particularly over global growth concerns due to China’s structural economic problems.

Worries over China's economy are also fueling risk aversion in markets. The country's Politburo has referred to the economic recovery as "tortuous", with weak economic data persisting. Falling consumer prices on weak domestic demand highlight the risk of deflation, along with lacklustre imports and poor export performance. Investors will be watching closely to see how these factors continue to impact financial markets in the coming weeks.

Markets viewed last week’s FOMC decision positively, with the Fed decidedly less hawkish, allowing for expectations that the US has reached the peak of its current interest rate hike cycle, spurring a "risk on" footing among investors. 

No further changes are anticipated to US interest rates this year, and markets are only essentially fully factoring in cuts in US interest rates from Q2.24. However, the diminishing chance of further hikes has cheered investors, as has the likelihood of a large stimulus package for China.  

The IMF warned on China’s growth in the publication of its World Economic Outlook (WEO) report released last week, noting “China’s recovery is losing steam … in part as a result of unresolved real estate problems, with negative cross-border spillover." The report also noted that foreign demand for Chinese goods has been subdued, "and rising and elevated youth unemployment indicates labor market weakness." However, it added, "Stronger policy support in China particularly through transfers to households could further sustain recovery and generate positive global spillovers. Scope exists for more favorable surprises to domestic demand around the world”.

The IMF revised up its forecast on global growth for 2023, to 3.0% y/y from 2.8% y/y, although still lower than 2022’s 3.5% y/y. The IMF also projects global growth at 3.0% y/y for 2024, but both are “weak by historical standards”.

After a long period of risk-off (since April 2022) the markets are seeking good news, even marginal expectations of improvements, and this is seeing the rand gain, with further strength possible against the crosses in the remainder of this year.

The rand is trading just above R18.00/USD, after  reaching R17.69/USD on Friday, with SA’s MPC meeting this week expected to leave interest rates on hold – positive for the economy, but not the rand as the differential between SA and US interest rates has narrowed. 

US dollar weakness recently has been key in allowing the rand to pierce the R18.00/USD mark, with the US currency reaching 1.1248 to the euro on Friday, its recorded weakest rate since February last year, when the rand was near R15.00/USD to R15.50/USD.

Global stock markets have gained on the recent better than (market consensus) expectations of US inflation data, with global financial market’s risk aversion waning on hopes to an end to the US interest rate hike cycle.  

Markets have also been recalibrating their US inflation expectations on the low cost of living and production price inflation figures coming out last week, which saw rapid drops, while a notable lowering (disinflation) occurred in the core components. 

The worlds largest economy sees its next interest rate (FOMC) meeting close to the end of the month, 26th July, around a week after SA’s MPC meeting. A flat US interest rate outcome would be supportive of the rand, underpinning further strengthening. 

Weak economic activity in China is seeing the globe’s second largest economy signalling the potential for additional monetary policy support as the anticipated post COVID-19 lockdown restrictions recovery proves slow to take hold.

Market expectations of a soft landing globally for the world economy are adding to optimistic financial sentiment. In addition, the US’s University of Michigan (consumer) sentiment and current conditions data on Friday proved better than expected. 

However, investor concerns on domestic (SA) issues, including fragile economic growth are still weighing on the domestic currency, as are political concerns ahead of the 2024 election and worries over the future strength of state finances.

The rand is trading at R20.27/EUR and R23.60/GBP, having made notable gains against the key crosses, with potentially more strength to come, although weakness is likely to be marked on a disappointingly FOMC (higher interest rates) outcome.

After weakening on Friday, to R19.17/USD, the rand rebounded somewhat to R18.76/USD this morning, as US jobs market data on Friday showed that the labour market was still tight, with continuous strong wage gains causing some inflationary concerns.

In particular, hourly earnings posted a stronger than expected reading in the US on Friday for June, coming out at 4.4% y/y (expected 4.2% y/y) and 0.4% m/m (expected 0.3% m/m), while US wage growth has already been revised higher previously. 

Markets have taken this as affirming a potential further 25bp hike in the current US interest rate cycle, with the first opportunity at the end of this month (26th July). The US dollar strengthened somewhat in response, weakening the rand on Friday. 

The dollar has pulled back slightly as markets further digest the slew of US jobs data released on Friday afternoon, which showed the gain in non-farm payrolls disappoint at 209k versus 230k (prior 306k), evidencing some cooling although still robust.

In particular, gains in private sector employment (private payrolls), at 149k, was the weakest since 2020 (or 2019 if the anomaly year of COVID-19 is excluded), as the private sector dialed back on job creation.  

The disappointment in the change in US non-farm payroll figures was centered on the market expectation of 200k for change in private payrolls (versus the 149k which transpired), as the US government saw a marked hiring of 60k supporting the outcome.

The change in hourly earnings remain on a downwards trend since March 2022’s 5.9% y/y, but concerns over wage growth still persists with the Fed likely more comfortable with this variable around the 2.5% y/y to 2.0% y/y mark.

Lastly, the unemployment rate at 3.6% in June came out as expected, but was fractionally lower than the May figure of 3.7%. However, overall the jobs data has been seen as moving generally in the right direction.

For the rand the all-important US jobs data caused the domestic currency to weaken against the US dollar last week,  and then recover slightly this morning while against the euro and GBP it has made smaller gains today, at R20.56/EUR and R24.04/GBP.

The rand has generally run softer over the past week, with Central Banks’ hawkish communications quelling market hopes for interest rate hikes in H2.23, resulting in some EM currency weakness and US dollar strength.

ECB President Christine Lagarde highlighted in particular recently that “we are not seeing enough tangible evidence that underlying inflation, particularly in domestic prices, are stabilizing and coming down.” 

While BOE Governor Andrew Bailey is reported to have said on inflation that the concern is around “core — that’s the issue”, with both last week noting tight labor markets and higher wages supportive of inflationary pressures. 

US Federal Reserve Bank, Chair Jerome Powell, added to the hawkish monetary policy communications, stating “although policy is restrictive, it may not be restrictive enough, and it has not been restrictive for long enough”.

Markets are increasingly factoring out expectations of further interest rate cuts in the remainder of this year, and instead looking at some additional hikes as Central Banks focus on bringing inflation back to targets. 

Market exuberance on the start of an interest rate cutting cycle in H2.23 was overdone, and Central Banks are strongly communicating against this likelihood, but a continuation of the rapid interest rate hike cycle in the US is also not likely for H2.23.

Monetary policy also relies on communication to attempt to steer financial market expectations, and interest rate cuts despite weakening economic activity were always unlikely so soon with inflation still well removed from target ranges/points. 

The recalibration in market views has caused some subsidence of a modest build in risk taking (risk-on), and a return to a more risk averse environment in global financial markets, resulting in rand weakness, and that of other EM currencies. 

In South Africa, the Reserve Bank Governor, Lesetja Kganyago, underscored "what is in no doubt is that policy is going to have to remain tight for a little bit longer than actually the market had been pricing".

The Federal Open Market Committee (FOMC) statement, which followed its June meeting, disappointed market expectations that the US interest rate hike cycle is near its end, causing some EM currency weakness from which the rand/US dollar exchange rate was not spared. 

The US is likely purposely pushing hawkish communication in the face of high inflation, having highlighted the slow pace of disinflation (falling inflation) and its concerns over higher inflationary pressures becoming entrenched. 

"Considering how far and how fast we’ve moved, we judged it prudent to hold the target range steady to allow the Committee to assess additional information and its implications for monetary policy,” the statement read.

The Fed will consequently be even more sensitive to incoming data on the US economy, and much will depend on how the US economy “evolves” versus the Fed expectations for the economic outlook currently.

A weakening in the US economy would bolster market expectations for a weaker inflation outlook, and so for a lower interest rate trajectory, while stronger US data would tend to have the opposite effect, underscoring the likelihood of further hikes. 

Recently, the Bloomberg economic consensus survey results on the US show forecasts have improved for GDP, with the economy no longer expected to see two quarters of contraction, although inflation is now seen higher. 

This has added to market concerns and uncertainty. “Inflation pressures continue to run high," the statement continued, "and the process of getting inflation back down to 2 percent has a long way to go”. 

The rand is likely to remain volatile, influenced by global events more heavily currently, as lower loadshedding stages and President Ramaphosa’s recent efforts to strike a more neutral balance in global geopolitics have been overshadowed.

The rand has been rebuffed from the key R18.00/USD resistance level,  reaching R18.16/USD today (and R19.89/EUR and R23.27/GBP), although on Friday it temporarily recorded R17.86/USD, R19.84/EUR and R23.18/GBP (Iress data).

US dollar weakness has aided the rand/US dollar exchange rate as global sentiment  improves on disinflation (falling inflation), raising market expectations of interest rate hike cycles nearing their ends, and even cuts in the foreseeable future. 

In the US, PPI inflation, which typically leads CPI inflation, dropped down to 1.1% y/y in May, from 2.3% y/y, falling by -0.3% m/m, while the core PPI measures dropped to 2.8% y/y, from above 3.0% y/y  

The rapid easing in PPI inflation heralds some possible quickening in US CPI disinflation, and that of the core PCE deflator, and consumer sentiment is consequently becoming less depressed in the US.

Indeed, this measure of consumer sentiment (University of Michigan survey) tends to have a close relationship with US PCE spending (consumer expenditure), which is a large component of US GDP.

Also adding to improved global financial market sentiment, which tends to strengthen EM currencies such as the rand, was commentary from the IIF (Institute of International finance) last week highlighting a soft landing for the US economy.

The IIF (the global association of the financial industry) said in particular that the US should avoid a recession, while also indicating "a positive outlook for capital flows to emerging markets", with the IIF also seeing “a benign inflation view".

However, the IIF adds that it sees “the risks to this forecast as tilted to the upside, given that real incomes look set to rise and there are first signs of stabilization in the US housing market.” “We have had a dovish view on inflation for some time.”

Improving global financial market sentiment typically causes the rand to strengthen, however idiosyncratic factors remain for SA, and include the speed of resolution of its electricity and transport (Transnet) crises for growth and state revenue.

The rand has pulled stronger, to R18.55/USD, R20.00/EUR and R23.34/GBP from R19.50/USD, R20.80/EUR and R24.20/GBP a week ago, as the SA government seeks to strike a more neutral tone in its approach to the war in Ukraine and quell perceptions that it is siding with Russia.

Additionally, the state has been proactive in working to resolve the electricity crisis, while big business and the presidency have established a partnership initiative “to remove obstacles to inclusive economic growth and job creation”.

Markets have reacted positively to the government's announcement on 7th June outlining interventions on three agreed priorities: energy; transport and logistics; and crime and corruption. 

Also cheering the markets is the likely pause, if not end, to the interest rate hike cycle in the US this week, with the market not pricing in a full rate hike of 25bp in any of the upcoming three FOMC meetings of 14th June, 26th July and 20th September. 

Markets are now expecting interest rate cuts in the US from November, citing a slowdown in US economic activity, with May’s manufacturing PMI still below 50 at 48.4, indicating falling production. 

The US ISM (Institute of Supply Management) manufacturing reading for May was even lower, at 46.9 (again below the 50 threshold which indicates declining production), while ISM prices paid fell into negative territory at 44.2, also cheering given the US inflationary pressures.

However, US inflation is expected to fall further, both in terms of the headline measures and the core measures, which typically exclude the volatile components (such as food and energy), and US unemployment is up somewhat, although still low.

This week the US sees its CPI inflation figures released for May, and tomorrow is expected to see the core measure drop to 5.2% y/y from 5.5% y/y, and the headline measures to 4.1% y/y from 4.9% y/y previously.  

With a two to three quarter lag between a change in US interest rates and the impact on the economy, the US is largely expected to pause its rate hike cycle, bolstering the rand which was suffering from ongoing erosion of the interest rate differential.

With the rand at extremely weak levels, around R19.50/USD, R20.80/EUR and R24.20/GBP, the domestic currency has superseded the  severe down case forecasts of a few years ago, as South Africa’s outlook slides lower on many fronts.

The most recent collapse in the rand, to R20.00/USD, R21.24/EUR and R25.58/GBP by the end of May, from R18.24/USD, R20.10/EUR and R22.81/GBP at the end of April, was driven by SA’s perceived move away from neutrality to support for Russia.

The past month has revealed the strong relationship SA’s government is reported to have with Russia on many fronts, including reportedly close military ties, at a time when the Western world has imposed sanctions on Russia for its war on the Ukraine.    

South Africa’s ongoing relationship with Russia, including through the BRICS grouping sees the country scrambling to find a solution to the Russian President’s impending visit later in the year if SA hosts the BRICS summit.

The rand has pulled back towards R19.40/USD, R20.75/EUR and R24.08/GBP on discussions for the BRICS meeting to be hosted in a different country, to avoid the problem of the ICC ordering President Putin’s arrest, with SA an ICC treaty  member.

Petrol and diesel prices are in line to fall by 75c/litre and 88c/litre respectively this week on lower international oil and petroleum product prices, although the government’s slate levy can cause some variation to these movements.

If the rand had not weakened over May, prices would be set for a drop of R1.25/lite for petrol, and R1.34/litre for diesel this month instead, before the slate levy (compensation for fuel companies for fuel price fluctuations in the prior month).

The inflationary effect of rand weakness cannot be underestimated, negatively impacting living costs, particularly the lives of the poor whose biggest expenses are typically travel and food, both afflicted by the rand’s severe depreciation against the US dollar. 

SA’s geopolitical choices and particularly the revealed strength of its relationship with China, has seen the rand collapse and substantial foreign selling of SA’s financial assets as Western financial market players are punish SA for its deteriorated risk environment, including its perceived significant allegiances to Russia.

The rand has returned to levels of around  R19.52/USD as foreign investor sentiment towards SA remains very negative, with electricity outages worsening and no concrete progress yet in increasing power supply for this year. 

Markets also worry about recession in the US, the nearing fiscal cliff and disappointment over the weakness of China’s recovery, while SA is expected to see an interest rate decision this week between a 25bp or 50bp lift, when a 75bp rise is needed instead to strengthen the rand meaningfully.

South Africa has seen the rand reach historic lows against the US dollar this year as global financial markets have seen sentiment turn increasingly risk averse, with the sell off of risk assets increasing, and SA having done little to shore up its currency.  

While we expect a 50bp lift, higher interest rates weaken the economy, along with substantial electricity and water shedding capacity and very weak rail and port capacity, all of which is negative for the rand and has seen the probability of the lite down case rise (see scenario table below).

Looking forward, interest rates are expected to fall next year in South Africa, if not by Q4.23 already, while inflation is likely to be lower in the second half of this year compared to the first half, and fall over 2024.  

Economic growth, while likely stagnating this year, is expected to lift successively over the next few years at an accelerating pace as renewable energy increasingly replaces Eskom’s falling production, and adding to fixed investment growth.

Globally, while markets continue to fret about the US debt ceiling borrowing limitation, and lack of action so far from the US Congress in raising it (an annual event which typically sees an eventual alleviating rise), this year tensions are high.

Treasury Secretary, Janet Yellen, estimates that the US is likely to run out of money by the start of June,  with failure to reach an agreement to raise the debt ceiling well before then risking market turmoil, and some fear igniting recession.

The rand has depreciated on US dollar strength as safe haven flows into US treasuries, increase in times of elevating risk aversion. The US is expected to resolve its debt ceiling crisis this week, as next week sees June beginning.

After reaching R19.52/USD on Friday, the rand has seen an about-turn as global financial market sentiment became less risk-averse against EM currencies, seeing the rand attempt to pierce the R19.00/USD resistance level this morning. 

Volatile markets are currently taking cheer on the anticipation that the US has essentially completed its rate hike cycle, with the US dollar expected to weaken in the remainder of this year, boosting EM currencies.

Markets will be seeking EM currencies offering significant inflation-adjusted (real) returns, and with SA seeing only a modest interest rate hike cycle compared to some of its EM peers, it is not expected to be the most significant gainer.

A 50bp hike instead of a 25bp lift at the SARB’s MPC meeting next week will provide some positive momentum to the rand, as would an improvement in commodity prices, with the rand lifting on general improvement in sentiment currently.

The rand is trading around R19.05/USD, R20.70/EUR and R23.80/GBP, after reaching R19.52/USD, R21.33/EUR and R24.46/GBP on Friday, with risk aversion towards SA also subsiding somewhat as SA looks to emergency power provision.  

Both President Ramaphosa and Electricity Minister, Kgosientso Ramokgopa, stated recent support for Karpowerships emergency supply at the end of last week, boosting domestic sentiment as concerns of higher load shedding stages grow.

SA has put in place protocols up to stage 16 load shedding recently, which negatively affected market sentiment. President Ramaphosa affirms “what South Africa needs right now is emergency energy… Other countries have done so.” 

“I have been to a few countries that have brought in ships that are able to generate energy and immediately solved their energy problems and challenges. I believe that that is the way to go right now, to add those megawatts that we don’t have”.

The President is also reported to have said allegations SA supplied arms to Russia are a “distasteful attack” on SA. A further improvement in global financial market sentiment could see the rand move below the key resistance level of R19.00/USD. 

The rand remains around R18.30/USD, still seeking a directional driver as a risk averse environment persists in global financial markets, and  so for EM markets and currencies. Monetary policy globally is also seen to likely have some divergence.

While the financial markets have taken the latest Fed interest rate decision meeting as reaching the terminal (highest range for the fed funds) rate in the current US interest rate hike cycle, the FOMC statement was not definitely clear on this. 

The ECB, however, has clearly said that its recent hike is not the last in the current cycle, with ECB President Christine Lagarde stating “(w)e have more ground to cover and we are not pausing, that is extremely clear”.

The benchmark deposit rate of the ECB is now at 3.25%, lagging the rapid pace of hikes in the US, with the focus firmly on subduing inflation still, and that this month’s hike would not be the last this year, despite monetary policy in “restrictive territory”.

In South Africa, a 25bp hike is fully factored in for the repo rate, and indeed the FRAs are pricing in a 33bp lift at SA’s meeting on 25th, still leaving some space for a repeat of the last MPC move when the SARB lifted its Bank rate by 50bp.  

The US has hiked by a huge 500bp to date in its current cycle, and South Africa by only 425bp, causing the differential between SA and US interest rates to drop substantially during a risk averse period, which has weakened the rand.  

In a risk off environment, SA should offer a higher risk premium return on the rand, not a lower one, in order to keep the rand stable, but the erosion of the differential between SA and US rates has lowered the risk premium instead.  

Consequently, it is no surprise that the rand has weakened substantially over the past twelve months of risk-off in global financial markets, from R14.50/USD to R18.50/USD, as the US dollar has strengthened and the rand weakened.

The rand has also reached R20.43/EUR and R23.31/GBP, from 15.65/EUR and R18.77/GBP mid-April 2022, with this broad based rand weakness most likely to add to inflationary pressures in South Africa as the pass through effect has escalated.

The past week saw one of the Fed’s preferred measure of inflation, the core PCE deflator drop to 4.2% y/y, from 5.0% y/y in April, although slightly higher than the 4.1% y/y expected. This week the FOMC meeting is still expected to see a 25bp hike. 

The rand largely stagnated around the R18.30/USD mark last week, particularly towards the end of the week, in the build up to the US interest rate decision, with the FOMC statement in key focus as markets await communication on the terminal rate.  

The Fed is expected to signal at Wednesday’s meeting that it has neared the end of its interest rate hike cycle, or at least will pause for a significant amount of time to allow the lagged effects of interest rate hikes to come through in the economic data. 

With around a two to three quarter lag between interest rate hikes and the impact on the economy, the rapid US rate hike cycle over last year, and this, has not fully reflected in the economic readings on activity, with a US recession still feared. 

The Fed is widely expected to raise its funds rate by 25bp tomorrow evening (SA time), with the implied futures seeing a 95% probability, but the following FOMC meeting is not expected to see a hike, on 14th June this year.

That is, there is less than a 30% chance factored in by the implied Fed funds futures for a further 25bp hike in US interest rates this quarter, and in H2.23 no interest rate hikes at all are anticipated by the markets, nor in January 2024.

From July this year already (with  the FOMC meeting on the 26th) markets think cuts in US interest rates would be more likely than hikes, while by November (with the FOMC meeting on the 1st), a 25bp cut is fully factored in by the markets.

December sees a further 25bp cut in the Fed funds rate built into the implied Fed funds futures, while a further one is fully factored in for the January 2024 FOMC meeting on the 31st.

For South Africa, the FRAs have factored in about a 40bp hike in SA’s interest rates for its next MPC meeting, on 25th May, closer to a 50bp than a 25bp hike, which would boost the rand if it occured, likely causing it to strengthen below R18.00/USD.

Markets continue to worry that the US will fall into recession in H2.23, as its interest rate hike cycle overshoots. With at least a two to three quarter lag between interest rate changes and the impact on the economy, further US hikes are entrenching recession concerns.

With mixed US economic data, there is (lowish) volatility, with the domestic currency reaching at R18.20/USD today, on some US dollar strength on better-than-expected S&P PMI data on Friday, from a recent low of R17.42/USD on Friday.

The US PMI data in particular showed upwards price pressures at the production level which increased some expectations of US interest rate hikes, and so aided the US dollar, although by midday the rand had pulled back to R18.11/USD.

Stronger US demand

Friday’s US PMI report highlighted that “(s)tronger demand conditions support sharper growth in April, but also bring renewed inflation momentum”, as US business activity was seen to have quickened in April across the services and manufacturing sectors. 

“Output rose at the sharpest pace for almost a year, as stronger demand conditions, improving supply and a steeper uptick in new orders supported the expansion. … The increase in output was the third in as many months.”

“The faster rise in activity was broad-based, with service sector firms registering the sharper rate of growth … linked this to greater customer confidence and … (s)ome … improvement in their ability to hire staff had boosted output.”

“April data indicated a pick-up in rates of input cost and output charge inflation. Operating expenses rose at a marked and historically elevated pace that was the steepest for three months, seen as contributing to core inflation”.

In the US, core CPI inflation (CPI excluding food and energy) rose to 5.6% y/y in the latest print, up from 5.5% y/y, obdurately high, and the PMI data raised some concerns it would further support Fed hawkishness. The core PCE deflator is due this week. 

Rand impacted by uncertainty over the US

Financial markets are factoring in almost a 100% change of a 25bp hike in the US next week, while expectations of a recession are a lot lower, at 44% according to NABE (National Association of Business Economics). Uncertainty is elevated. 

That is, the rand’s weakness over the past year has been driven by increased uncertainty and the downgrades of the global economic outlook, as uncertainty elevated, although another sharp depreciation in the rand is not the base case.

With global risks, and particularly a meaningful chance of US recession factored in (although likely not fully), the rand remains at risk of further weakness, but is not expected to lose another R4/USD over the next twelve months. 

US recession on the cards?

The NABE recession outlook is down from 54% in January, while Forbes’ recession tracker shows “more and more of our data points are drifting into neutral territory rather than remaining positive.”

“This could mean the U.S. is drifting closer toward a recession as well, … however, … not every data point we rank above would be weighted equally in deciding whether the U.S. is in recession.” 

“If GDP can continue growing—which experts seem to believe is unlikely—while inflation moderates, we may be able to avoid a recession and come in for what the Fed has referred to as a soft landing.”

“Even the US unemployment rate, which figures heavily into when a recession might be called, is starting to weaken. The U.S. may not be in a recession yet, but things aren’t looking good.”

Sentiment, amongst other factors, has a part to play in whether the US achieves the NBR defined recession (National Bureau of Economic Research), of roughly a contraction in the business cycle (after the peak), with a number of areas of focus.  

“Monthly US data on payroll employment, civilian employment, industrial production and the unemployment rate are used to define a recession-dating algorithm that nearly perfectly reproduces the NBER official peak and trough dates.”

Activity in the US business cycle is expected to slow in H2.23, but whether it will be enough for  a NBER defined recession is not clear, giving hope for a ‘soft-landing’, although much will also depend on global financial market risk perceptions for the rand.

The rand temporarily pierced R18.00/USD on Friday, and ran near the key resistance level of R18.00/USD this morning.

Sentiment on US growth has dimmed for this year, driving the subsidence in interest rate hike expectations, along with concerns still over the impact of the sharply higher US rate hike cycle to date on the health of the US banking system.

The IMF warns “below the surface, however, turbulence is building, and the situation is quite fragile, as the recent bout of banking instability reminded us the sharp policy tightening … is having serious side effects for the financial sector”.

“Financial institutions with excess leverage, credit risk or interest rate exposure, too much dependence on short-term funding, or located in jurisdictions with limited fiscal space could become the next target.”

“So could countries with weaker perceived fundamentals. A sharp tightening of global financial conditions—a “‘risk-off” shock—could have a dramatic impact on credit conditions and public finances especially in emerging market and developing economies”.

“With large capital outflows, a sudden increase in risk premia, a dollar appreciation in a rush toward safety, and major declines in global activity amid lower confidence, household spending, and investment.”

“In such a severe downside scenario, global GDP per capita could come close to falling— an outcome whose probability we estimate at about 15 percent.” Markets are cautious as the full effect of rate hike cycles have not been felt yet.

“We are therefore entering a perilous phase during which economic growth remains low by historical standards and financial risks have risen, yet inflation has not yet decisively turned the corner.”

With financial markets already concerned by higher interest rates, which has driven varying degrees of risk-off sentiment in global financial markets over the past twelve months, the cautious tone taken by multilaterals recently has been seen as positive.

The rand has traded weaker in increasingly risk averse markets, with the domestic currency weakening to R18.62/USD, R20.13/EUR and R22.94/GBP on Friday, today only having pulled back modestly so far in thin trade.

On Thursday the IMF said global economic growth is likely to “remain at around 3% for the next five years”, its “lowest medium-term growth forecast since 1990, and well below the average growth of 3.8% seen in the past two decades.” 

“Growth prospects remained weak given persistently high inflation. Bank failures in Switzerland and the U.S. had exposed financial vulnerabilities that increased the downside risks for the global economy”. 2023’s growth is also seen below 3.0% y/y.

Further warning “geopolitical fragmentation, driven by tensions between the U.S. and China, risks damaging the global economy, with foreign direct investment and other capital increasingly being channeled toward aligned blocs of countries”.

Domestically, Eskom whistleblower, Andre de Ruyter, is reported to have said “Eskom’s various power stations have experienced widespread sabotage, criminality, and destructive and unlawful industrial action”.

“It is clear that damage to Eskom property and operations has been deliberate” with a “sustained campaign of sabotage”. The new electricity Minister, Kgosientsho Ramokgopa, warned last week of up to stage 10 loadshedding this winter.

Minster Ramokgopa said “now we are entering winter, which is going to be a very difficult period. The numbers suggest that historically the average demand is about 35,000MW, but it can go up to 37,000MW”. 

“On average, Eskom can guarantee us about 27,000MW, and we know that peak demand in summer is about 32,000MW.” Higher demand will widen the gap in the electricity shortfall, negatively affecting economic growth and investor demand.

The rand has weakened against the crosses, reflecting continued strong risk-off sentiment in global financial markets, while data has disappointed recently from China and risk of US recession is seen as rising again.

The substantial effect of South Africa’s Reserve Bank hiking interest rates by more than expected last week has set the rand at a new level, with the domestic currency reaching R17.60/USD on Friday, despite some small US dollar strength.

South Africa’s interest rate hike was 25bp higher than expected at 50bp, the rand has strengthened by over R1/USD since the R18.81/USD reached around the middle of March, although the US banking crisis has since waned as well.

The rand continues to be at risk, and will so remain volatile, vulnerable to global financial market sentiment, with fundamental weaknesses in the domestic economy still providing a weak underpin to the domestic currency.

As risk sentiment improves in the global economy the rand should too, provided SA does not enter a more severe bout of load shedding, see a worsening in its other factors of production or other domestic factors necessary to support businesses.

The expectation of additional US interest rate hikes have been largely factored out with only one more 25bp lift seen, with a 65% chance currently, while in SA a full 25bp hike is factored in over the next six months, supporting the rand.

The erosion in the risk premium necessary on SA rand portfolio assets had weakened the rand materially over the past twelve months, as SA’s interest rate hikes have failed to keep up with those on the US. SA is now 50bp behind the US.

The US has hiked by 4.75% in its current cycle, and SA by 4.25%, with SA seeing rate hikes every two months and the US every six weeks, resulting in a quickening in US rate hikes beyond those in SA, even with the same size hikes at each meeting.  

A further 50bp hike in SA’s interest rates, and no more from the US would most likely see the rand strengthen materially further, which would help in reducing the marked upwards pressure on SA’s price inflation, which has come from rand weakness. 

Market risk sentiment has elevated somewhat as the production cut from OPEC yesterday saw oil prices rise materially today, with higher oil prices typically supportive of higher inflation and interest rates, and so negative for risk assets.

Risk aversion has not fallen for emerging markets yet, despite growing expectations that the end of the US rate hike cycle is now in sight and the FOMC predicting over 1% in cuts in its fed funds rate next year, which markets think will start in H2.23.

Concerns over the health of private sector banks in advanced economies are supporting risk-off, as are worries over still high inflation, while the ECB and BOE warn of further rate hikes to tame inflation.

Fears over systemic risk have intensified in the banking sector, with the IMF warning “risks to financial stability have increased … at a time of higher debt levels”, and that the outlook for the global economy is weak for the medium-term. 

“The rapid transition from a prolonged period of low interest rates to much higher rates inevitably generates stresses and vulnerabilities, as evidenced by recent developments in the banking sector in some advanced economies."

“Policymakers have acted decisively in response to financial stability risks, and advanced economy central banks have enhanced the provision of U.S. dollar liquidity. These actions have eased market stress to some extent”. 

However, “uncertainty is high which underscores the need for vigilance”, with” risks of geo-economic fragmentation which could mean a world split into rival economic blocs … that would leave everyone poorer and less secure.”

Concerns that the banking crisis could worsen have overshadowed global financial markets, as this would risk a global recession. Markets are being cautious and so risk averse, which is limiting rand gains from the less hawkish FOMC stance. 

The rand reached R18.32/USD today, R22.42/GBP and R19.70/EUR, still weak, and foreigners have sold off -R13.6bn in SA bonds so far this year, while net sales of equities have been recorded too as foreigners continue to dump SA tocks.

Looking ahead, much will depend on market concerns around the banking system, and the shoring up of liquidity, with Central Banks rushing to reassure markets on their respective banking sectors health, but this is not allaying concerns currently.

The rand has settled just above R18.00/USD, heavily undervalued on both high risk aversion in global financial markets, and particularly negative investor sentiment against SA on its worsening growth outlook as its productive capacity deteriorates.

Against the euro and pound the domestic currency is trading near R19.50/EUR and R22.00/GBP, also heavily undervalued, and running poorly against the crosses,  near the bottom of the Bloomberg EM currency ranker on an annual comparison.

South Africa’s worsening electricity crisis came at a poor time against the backdrop of material risk off sentiment in global financial markets, while load shedding also adds to the cost environment, with SA’s inflation still high, weakening the rand. 

All the rating agencies have evinced concern over SA’s weakening economic growth outlook, with Moody’s recently having said “South Africa's longest-ever stretch of power cuts is credit negative”.

“We expect the blackouts' effect on businesses, consumer sentiment and investment will weaken the country's already subdued economic growth prospects and threaten social and political stability.” 

“To manage demand amid the breakdowns, Eskom cuts power up to 10 hours per day in different areas of the country for the past six months. South Africa has long experienced some degree of load shedding, but never to the current extent.”

Moody’s, one of the three key credit rating agencies globally, has highlighted that the effect on economic growth increases the chance of a downgrade, by terming load shedding credit negative for South Africa.

Rating agencies are taking a wait and see approach to SA’s electricity crisis. Moody’s expects SA “will accelerate the delivery of new power generation licences”, allowing “investment in utility plants, leverage economies of scale and liberalize the … energy market”.

Slow repair to the electricity crisis would increase SA’s downgrade risk. Moody’s recognises “implementation risks are significant and any real effects will take time to take materialize”. SA also has to make regular progress on addressing the shortcomings listed by FATF in its recent greylisting. 

The rand continues to be underpinned by weakness, unable to gain materially back to R17.00/USD without a substantial shift in global risk sentiment towards marked risk taking, or a resolution to the fundamental problems SA’s economy faces.

The US’s Federal Reserve Bank continues to weaken sentiment with its hawkishness, highlighting on Friday, again, that “ongoing increases in the target range will be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive.” 

The Fed was delivering its semi-annual report to Congress and concerns over high inflation and the diagnosis of such which includes the tightness of the labour market, and reasons for the labour force’s slow recovery towards normality. 

“More than half of that labor-force shortfall reflects a lower labor-force participation rate because of a wave of retirements beyond what would have been expected given demographic trends”.

“The remaining shortfall is attributable to slower population growth, which in turn reflects both the higher mortality primarily due to Covid and lower rates of immigration in the first two years of the pandemic.”

The lengthier normalisation of the labour market spells a higher and lengthier interest rate cycle in the US  with “(t)he committee … strongly committed to returning inflation to its 2% objective”, dampening investors risk taking.

Inflation concerns globally remain elevated for key advanced economies, with the eurozone seeing core inflation rising to a new historical record of 5.6% y/y from 5.3% y/y in January, and above expectations that it had stabilised at 5.3% y/y.

Overall, eurozone CPI inflation was also higher than forecast, at 8.5% y/y for February (January 8.6% y/y), versus the consensus view of 8.3% y/y, with services, goods and food prices accelerating quicker than expected.

The difficulty of taming inflation, particularly core measures, reflects high inflation expectations entrenching in tight labour markets, causing markets to further readjust their interest rate views as Central Banks take on lengthier hike cycles. 

The rand has lost ground over the past year due to the weakening global outlook and rapid hike cycle in the US, which has outpaced South Africa in raising interest rates in an effort to battle inflation. The US Federal Reserve aims to achieve a 2% y/y annual average core Personal Consumption Expenditure (PCE). This core inflation measure stood at 5.4% y/y on Friday, higher than both the expected and prior year readings. 

The PCE deflator reflects the strength of US consumer spending and the robustness of its economy. US retail sales and manufacturing also posted data that surprised on the upside last week. However, US home sales have weakened due to sharply rising interest rates.

South Africa is further negatively impacted by its inclusion on the FATF grey list, which raises the country's sovereign risk premium and so places additional pressure on the central bank to raise interest rates. FATF sets standards and promotes the implementation of legal, regulatory, and operational measures to combat money laundering, terrorist financing, and related threats to the integrity of the international financial system.

Once a country is greylisted, or formally placed under increased monitoring by FATF, it is also added to the “EU high-risk third countries list” by the European Union and the UK’s “high-risk jurisdictions” list. The IMF has found that greylisting has a large and significant negative effect on capital inflows, which decline by an average of 7.6% of GDP. South Africa already attracts extremely low foreign direct investment (FDI) inflows, with the bulk of activity on its capital account consisting of portfolio flows (purchases and sale of bonds and equities). 

While the rand has already factored in SA’s greylisting, the domestic currency saw a mild reaction on Friday, driven more by the high PCE deflator outcome. SA is likely to match the US hike in March and May, but there will be pressure for larger and more South African hikes and further rand weakness as South Africa disappoints.

Global financial market sentiment has become more risk averse, as market expectations of further US rate hikes have risen over this year on building concerns of a slower descent in key (core) inflation measures than initially hoped for. 

The implied Fed funds futures rate shows another 25bp hike expected in US interest rates next month at the 22nd March FOMC meeting, and a further 25bp by June but potentially occurring as early as the 3rd May FOMC meeting.

Markets had priced in only one more 25bp hike by the end of Q2.23 previously (market expectations just after the February FOMC meeting), leading to a reduction in risk sentiment, although this has now largely been reversed as risk aversion rises. 

Markets now worry that FOMC minutes (released Wednesday evening) for the 1st February meeting will see a steepening in the FOMC members rate hike expectations (dot plot chart), and a higher end (terminal) rate. 

Hopes of a pause in US rate hikes in March have eroded, as the US labour market remains strong, the US unemployment rate ticked lower in January (to its lowest rate in over 50 years) and non-farm payrolls came out nearly triple what was expected.

In addition, US core inflation fell by less than was anticipated in last week’s publication of the January figures, while headline CPI inflation in the US disappointed as well (and by a larger margin), causing market concerns to rise.

Fed Chair, Jerome Powell, has communicated that if the US economy does not see a marked slowdown, expected to be reflected in the labour market, then the US could speed up the pace of its rate hikes, as well as extend them. 

Better than anticipated data on the health of the US economy, and building market concerns over a more hawkish Fed approach has added volatility to the rand, which has lost ground too as the interest rate differential between the US and SA eroded.

SA has only hiked by 375bp to date, and the FOMC by 450bp, with the rand weakening materially as a consequence as the return on risk diminished comparatively, eroding the protective buffer for the domestic currency. 

The rand has breached R18/USD and is moving closer to R22.00/GBP and R19.50/EUR on the back of a combination of global and South African issues.

Locally, the ANC's increased interest in forming coalitions with far-left political parties at the municipal level has sparked negative investor sentiment, as has the country's energy crisis and the prospect of permanent load shedding.

Investors are concerned about a leftward shift in the ANC's orientation, following the party's coalition with the EFF in a number of municipalities. Should this alliance extend to national government following next year's election, business interests would be undermined and already lacklustre economic growth would be further hampered. Business sentiment is already at a low ebb due to a decrease in economic productivity caused by load shedding, deteriorating rail and port transport capacity and water supply insecurity.

On January 26th, SA's Reserve Bank (SARB) revised down its GDP growth forecast for this year to 0.3% y/y, after Eskom's announcement that load shedding is likely to be permanent this year. The SARB also lowered its economic growth rate forecast for the next two years.

Global financial markets are also concerned about the pace of disinflation, with the US implicitly targeting the core PCE deflator measure, which is proving sticky, as are most core measures. Federal Reserve Bank Chair Jerome Powell recently warned that returning inflation to its 2% target will take "quite a bit of time," as evidenced by recent strong US employment data figures.

The US dollar has strengthened over February, as risk sentiment has deteriorated somewhat on a recalibration of expectations for a more moderate descent in US core inflation.

The rand is weaker this week, having dipped below R17.00/USD, to R16.93/USD, after the FOMC meeting, but today has reached R17.69/USD, as markets still see some risks in the US inflation and interest rate outlooks.

While the Fed last week was careful to highlight its rate hikes are not at an end, and core measures of inflation (excludes the volatile prices of food and energy) are proving sticky (slow to come down), and not just in the US.

US Treasury Secretary Yellen reiterated this week that she does not expect a US recession, and legislative measures will aid inflation to fall more rapidly, but markets have started to worry about inflationary effects of stronger than expected economies.

The US implicitly targets a core inflation measure of 2.0% y/y, a rate which is not seen as too high or too low for price increases, with higher rates of inflation having a negative effect on the cost of living.  

Aiming for too low a rate of inflation risks deflation, an environment where consumers delay purchases, waiting for even lower prices to come, and economic and investment drops while unemployment rises. 

A 2.0% y/y inflation target also provides some buffer to under measurement of inflation, a situation when actual inflation proves lower than the official measurement and so risks nearing deflationary (falling prices) territory. 

Deflation has further negative consequences, which include increasing the real value (the real value removes inflationary effects) of government debt, while conversely inflation reduces the real value of debt.

South Africa sees its State of the Nation Address (SONA) on Thursday night, but markets anticipate little game changing reforms, with many past priorities unfulfilled and the economic environment instead deteriorating on weakening infrastructure.

The rand has weakened on falling  electricity supply, lack of broad state support for Eskom’s CEO, and Transnet failing to meet rail and port capacity needs, while the size of the government and its poor governance is feared to increase under the NHI.

The persistence of loadshedding has eroded investor confidence in the domestic economy, with no state solution to end the damaging effect on the economy in the near term, as we have been increasingly noting over the course of this month.

January typically sees seasonal strength in the rand, but this year market players are penalising the domestic currency, as the state fails to allay investor concerns over the electricity crisis (see rand note of 23rd January 2023). 

Additionally, Transnet’s deteriorating ability to meet demand for its rail and port transport services has further dented investor and business confidence, threatening export-led growth, and afflicting the rand (see rand note of 16th January 2023).

The rand reached R17.29/USD, R18.80/EUR and R21.37/GBP on Friday, trading weaker this morning against the key crosses, as investor sentiment against SA has dipped, and the interest rate differential with the US has not narrowed significantly.  

SA’s growing electricity crisis implies a substantially weaker 2023 outcome for the economy as we have increasingly noted this year so far, well below the 1.1% y/y growth rate we had forecast end December/start January (likely closer to 0.6% y/y). 

Already industrial production contracted in the first two months of Q4.22, down by -1.4% versus the same period in Q3.22 (seasonally adjusted) for South Africa, on the country’s deepening supply side energy shortages. 

Additionally, Eskom faces high and rising costs from its usage of diesel to fuel open-cycle gas turbines, and desperately needs cash injections (and a wholesalers license) to purchase diesel, absent which the stages of load shedding have risen.

The looming threat of stage 8 load shedding, and outages including stage 6 so far, have eroded confidence in the domestic economic outlook, with no government solution in sight in the near-term, pushing the rand weaker (rand note 16th January 2023).

Little improvement is expected this year in terms of state infrastructure, particularly on the rail, port, electricity and water supply front, which will impede economic growth and so job creation, keeping the rand weak (rand note 9th January 2023).

The rand reached R21.49/GBP and R18.81/EUR on Friday, weakening over the course of this month against the USD as well, although to a lesser extent as the greenback lost some ground itself.

Risk aversion has subsided in global markets somewhat, as the economic outlook is not seen to be as dire for this year as was previously feared, which has seen safe haven flows into the US lessen. 

The IMF said last week amidst the World Economic Forum’s (WEF) Davos meetings that “the IMF projects 2023 to be a difficult year and for growth to fall further, we don't expect a global recession.” 

Adding “resilient labor markets and consumer spending, the post-Covid reopening of China and signs of inflation trending downwards” are creating a more optimistic outlook, although risks persist.

Specifically IMF Managing Director Kristalina Georgieva told a panel of the WEF “that what had improved was the potential for China to boost growth and that the IMF now forecast Chinese growth of 4.4% for 2023.”

However, she saw no "dramatic improvement in the current IMF 2023 global growth forecast of 2.7%”, while “the war in Ukraine remained a tremendous risk for confidence, particularly in Europe.” 

The US has reached its debt ceiling again, at its US$31.4trillion borrowing limit, with the Republican-controlled House of Representatives and President’s Democratic party not agreeing to raise the limit, risking a fiscal crisis in a few months. 

The US Treasury is using extraordinary cash management measures to delay default, which will give some breathing room until early June, with  Republicans expected to push for spending cuts from the Democratic-led Senate.

The US has reached its debt ceiling many times before, with markets largely ignoring the event, focusing instead on the waning market expectations on US rate hikes as US inflation, and areas of its economy, cools.

The rand has attempted to consolidate below R17.00/USD, having achieved this for its daily close since Wednesday last week, while against the euro it is now above R18.00/EUR, as the euro returned to above parity against the USD in November. 

The rand has however calmed against the GBP, dipping to R20.48/GBP early this morning, versus R21.93/USD at the start of December, while the domestic currency reached R18.00/USD on that day, but since then risk aversion has subsided materially.

Friday saw stronger than expected GDP data from the UK for November, reducing fears of recession, as “telecommunications and computer programming” pushed “the economy forward. Pubs and bars also did well” on “World Cup games" - ONS.

Germany’s statistical agency also highlighted at the end of last week that the Eurozone’s largest economy likely avoided a recession “based on our current knowledge, GDP stagnated in the fourth quarter . . . after growing in the third quarter”.

The IMF is sounding more positive on global growth, highlighting most recently that “the U.S. can still avoid tipping into a recession, not least because of labor market resilience” which it described as "remarkable”.

Echoing our view, the IMF now believes that "the trajectory of slowing global growth to reverse in the second half of 2023, possibly towards the end of 2023, and then to see in 2024 higher growth than we had in 2023."

Furthermore “China is the single most important factor for global growth this year. If they stay the course, (around) mid-year China will turn into a positive contributor to average global growth".

The US saw lower than expected annual price inflation pressures, and markedly better than anticipated consumer sentiment, in the University of Michigan data released last week,  adding to the improvement in risk sentiment. 

US PPI data is due this week Wednesday, and is expected to show some ‘deflationary’ price pressures, adding to some further improvement in sentiment, although the rand is likely to remain volatile, having returned to above R17.00/USD (R20.90/GBP) by this afternoon.

The rand is treading water, nearer R17.00/USD today versus Friday’s R17.49/USD, as market risk aversion pulls back somewhat from the end of last week’s US labour market figures, in a typically quiet period at the start of the year. 

The rand modest strength today comes after Friday’s R17.49/USD, when the US dollar strengthened on data showing good labour market conditions, and causing some expectations of US rate hikes potentially falling away more quickly, to abate.

However, the rand is still weaker today, at R17.02/USD, than the middle of last week  when it reached R16.78/USD. Last week also saw the release of the US PMI readings, and, with readings below 50, indicative of weakening economic activity. 

The US manufacturing PMI showed activity falling over Q4.22, now at lows last experienced in 2020, and evidence of the effects of the US interest rate hike cycle, along with the weak services PMI, and overall composite PMI, readings.

Additionally, the US’s ISM manufacturing reading in negative territory saw new orders, production and supplier deliveries reflecting contracting activity, with the FOMC showing some concern over the US economy at its last meeting.

A number of  US data readings came out weaker than expected last month, adding to hopes that the US would stick to a slowing rate hike trajectory, which would weaken the dollar, although volatility is likely in the data, and so for the rand.

China’s reopening  has room to lift sentiment however, which may result in a better than expected GDP outcome for the country in Q1.23, although markets retain some skepticism, with substantial COVID-19 outbreaks and state reactions seen as risks.

Europe has coped better with winter heating and other fuel demand than feared so far, which has added to some improved sentiment, while a particularly warm January is now underway, easing the gas crisis. 

Holding back the rand domestically, little improvement is expected this year in terms of state infrastructure, particularly on the rail, port, electricity and water supply front, all of which are severely impeding economic growth and so job creation.

The 50bp lift at 14th December’s Federal Open Market Committee (FOMC) meeting, with the target range for the federal funds rate now 4.25% - 4.50%, was expected, but aided the rand in tracking back to R17.00/USD by the end of 2022 on USD weakness.  

The rand strengthened to R16.87/USD today, with the release of the FOMC minutes for the mid December 2022 meeting showing a unified decision to slow the pace of rate hikes in order to limit the impact on economic growth in the US.

In particular, in “(i)light of the heightened uncertainty regarding the outlooks for both inflation and real economic activity, most participants emphasized the need to retain flexibility and optionality when moving policy to a more restrictive stance.” 

Markets are beginning to factor in the chance that the FOMC reduces the quantum of its rate hike increases further, to 25bp potentially as early as the 1st February FOMC meeting, although market expectations are also divided, with the futures consequently pricing in a 34bp lift currently.  

The Fed funds futures further show less than a 25bp hike at the 22nd March and 3rd May FOMC meetings – the FOMC’s next two meeting dates, and then stabilisation around mid-year, turning to cuts in US interest rates over H2.23.

However, as the FOMC itself notes “the Committee would continue to make decisions meeting by meeting”, while the updated dot-plot chart shows the Fed’s target rate peaking at the 5.00% - 5.25% range, then dropping down to 4.00% - 4.25% next year.

The dot-plot consequently shows a higher peaking for the target rate for this year than in its previous publication of 4.50% to 4.75%, which has prevented the rand from strengthening (the US dollar from weakening) more substantially than it has from mid-December so far. 

However, Fed Chair Powell highlighted on the dot-plot (FOMC members’) interest rate views “of course, these projections do not represent a Committee decision or plan, and no one knows with any certainty where the economy will be a year or more from now.”

With the global economy expected to weaken this year, and the IMF warning "we expect one-third of the world economy to be in recession", markets are concerned as they show  US rate cuts later in the year. Investor uncertainty is still high, and so the rand is weak.

The rand has pulled back to R17.19/USD today, after weakening to R18.03/USD last week Thursday on fears that the flawed Phala Phala report, which lacked concrete evidence in its accusations, would cause President Ramaphosa to resign, as he initially indicated.

As the report was unpacked and seen to rely on unfounded information and rumors, the President is said to have reconsidered. A poll this weekend (by the SDR - Social Research Foundation) showed only about a third of voters would vote for the ANC without Ramaphosa.

The currency has not retreated to levels before the release of the report however, as concerns still centre on the President’s statement itself, along with some issues raised by the judges on the panel, and the increased domestic political risk has weakened the rand. 

The rand was also constrained in its reaction to the Phala Phala report by less hawkish comments coming from the Fed Governor, Jerome Powell, on Wednesday night, indicating the likelihood of a smaller rate hike in December in the US.

In addition, the rand’s continued partial recovery today was aided by China increasingly loosening its zero tolerance stance against Covid-19 over the past weekend, reducing some of the fears about a harsher global economic slowdown than originally feared. 

Risks still abound however, and the rand consequently remains above R17.00/USD. The Fed Chair continued to signal further rate hikes in 2023, highlighting that “it is likely that restoring price stability will require holding policy at a restrictive level for some time.”

Furthermore, “in the labor market, demand for workers far exceeds the supply of available workers, and nominal wages have been growing at a pace well above what would be consistent with 2 percent inflation over time.” 

“Thus, another condition we are looking for is the restoration of balance between supply and demand in the labor market.” But noted, “monetary policy affects the economy and inflation with uncertain lags, and the full effects of our rapid tightening so far are yet to be felt.”

This does not mean US rate hikes are at an end, but instead the Fed is becoming more sensitive to impact of rate hikes on the economy. Markets perceive this as less chance of the Fed over tightening, but the rand is unlikely to return to R14.50/USD it reached in Q1.22.

FitchRating (the credit rating agency), gave South Africa a country review on Friday (25th November) and left the rating unchanged at BB- as widely expected, along with a stable outlook. The rand did not react materially, with the outcome largely priced in.

Fitch specified “South Africa's 'BB-' IDR is constrained by high and still rising government debt, low trend growth and high inequality that will continue to complicate fiscal consolidation … at this stage we assume a substantial part of recent higher revenues to be temporary.”

And that it “sees current public sector wage negotiations pointing to increased upward pressure on spending”. The agency warned a “significant increase in government debt/GDP, for example, due to a persistent failure to narrow the fiscal deficit would see a downgrade”. 

Currently however, “the affirmation and Stable Outlook take into account substantial recent over-performance on fiscal revenues and the government's strong efforts to control expenditure, which if successfully continued, could bring about debt stabilisation”.

The agency also noted“factors that could, individually or collectively, lead to positive rating action/upgrade: are increased confidence that government debt will stabilise, for example due to signs of persistent high tax collections combined with successful expenditure control”.

And on the macroeconomic performance, policies and prospects side Fitch said that if it had “greater confidence in stronger growth prospects, sufficient to support fiscal consolidation and address challenges from high inequality and unemployment” SA could be upgraded.

A positive for SA is that its “ratings are supported by a favourable debt structure with long maturities and denominated mostly in local currency as well as a credible monetary policy framework.”

However the agency also warned of a “further weakening of trend growth or a sustained shock that further undermines fiscal consolidation efforts and raises socioeconomic pressures in the face of exceptional inequality” as leading to a credit rating downgrade.

Overall the credit review was mixed, with insufficient factors to place SA on the path for a definite upgrade yet from Fitch. Instead, the rand weakened today as risk aversion rose in global financial markets, in what is still a volatile and uncertain environment.

Standard & Poor’s rating agency (S&P), gave South Africa a credit rating review as expected on 18th of November, but did not provide any upgrade to the rating, and left SA on a positive outlook. The rand did not react materially, with the outcome largely priced in.

While Moody’s was scheduled to provide a credit review, it did not do so which is not unusual. Its stable outlook was maintained, as was the Ba2 (the BB equivalent) rating. S&P already had a positive outlook attached to its BB- rating of SA, and left this unchanged on Friday.

S&P said at the end of last week “the positive outlook reflects our expectation that a net external creditor position, a path toward fiscal consolidation, and the implementation of some structural reforms could lead to an easing of fiscal and economic pressures.”

S&P moved SA’s outlook to positive in May, clarifying last Friday it could raise the rating ”if growth in economic output and fiscal consolidation continue on a sustained basis, against a backdrop of structural and governance reforms and supportive external sector dynamics”.

However, it also warned “we could revise the outlook to stable if external or domestic shocks subdue South Africa's economic growth over the forecast period, or if fiscal financing or external pressures significantly increase.”

“This could, for example, result from a sharper global economic downturn, particularly in China”, although it does expect that economic “growth will slow but remain stronger than pre-pandemic levels”.

Adding, “downside risks could be exacerbated by the ongoing domestic electricity and infrastructure constraints, along with a sharper economic slowdown in China and the rest of the world.” Additionally, “medium-term fiscal risks remain significant.”

“Our forecasts are more conservative - we forecast the deficit will only marginally narrow to 4.6% of GDP by fiscal 2025, from 5.1% of GDP in fiscal 2023. Our assumptions incorporate lower revenue growth.” The tone of the S&P review was not as positive as hoped by some.

After opening today not far removed from Friday’s close, the rand has weakened modestly to R17.46/USD. S&P’s review does highlight a number of concerns which markets also share as well, with a move to a credit rating upgrade unlikely to be plain sailing.

The rand has continued to run stronger this week, reaching R17.14/USD yesterday, as expectations consolidate that the US will slow its rate hike cycle to 50bp in December, with recent comments from a key Fed member helping the US dollar weaken. 

In particular, the Federal Reserve Bank’s Vice Chair, Lael Brainard, is reported to have said on Monday this week that she “thinks it will probably be appropriate, soon, to move to a slower pace of increases.” 

“But I think what's really important to emphasize is we’ve done a lot, but we have additional work to do...By moving forward at a pace that’s more deliberate, we’ll be able to assess more data and be better able to adjust the path of rates to bring inflation down."

The FOMC’s vice Chair added, “there are likely to be lags and it’s going to take some time for that cumulative tightening to flow through,” adding a more cautious note to the formation of monetary policy than has come from Chair Powell so far. She added the below:  

"It's really going to be an exercise on watching the data carefully and trying to assess how much restraint there is and how much additional restraint is going to be necessary, and sustained for how long, and those are the kinds of judgments that lie ahead for us".

Markets have reacted positively to the caution, which has stimulated some small risk taking, driving the domestic currency towards R17.00/USD with the possibility that it could pierce R17.00/USD in the next few weeks on additional wind back in US FOMC hawkishness.

While the comments are not official Fed statements, they align closer to market expectations for a slowdown  to a 50bp hike in December versus the recent 75bp moves, and so add to some small market cheer. For the rand the drop in the CDS spread is also positive.

Volatility and a degree of uncertainty are likely to persist however into the December meeting, with financial markets still very reactive to incoming US economic data, but there is space for further improvement in risk appetite, and so for the domestic currency. 

Averaging R18.00/USD for the first six weeks of Q4.22, around R17.00/USD for the next six weeks will bring Q4.22 to R17.50/USD, although the path will likely be volatile,  with a slew of key US readings out before the 14th of December interest rate communication of the FOMC.

The rand closed at R17.90/USD on Friday, and today reached its strongest point at R17.75/USD, after initially weakening on the September FOMC meeting to R18.53/USD as members signalled they raised expectations of the ultimate level of interest rates.

Attention is turning to SA’s own monetary policy meeting this month (24th), with the MPC increasingly expected to deliver a 100bp hike, which would bring the cumulative size of SA and the US interest rate hikes in line in the current cycle. 

That is, the US so far has hiked by 3.75% in the current cycle, while SA has only hiked by 2.75%, which has narrowed the interest rate differential between the two countries, and supported rand weakness, with a 100bp hike temporarily restoring the balance. 

Markets have interpreted the FOMC statement as implying that a 50bp hike will occur in December and another in February 2023, slowing the pace of rate hikes in the US, which has seen 75bp lifts at the last four meetings, allowing for some US dollar weakness since. 

SA in contrast has only hiked by 75bp twice this year, and over the current interest rate cycle, causing the compression in the interest rate differential, and adding to rand weakness, with the FOMC meeting every six weeks, and SA two months, adding to the discrepancy. 

The rand strength has been limited, but likely still encapsulates the good news from the mini-Budget last month, which shows more planned fiscal consolidation than anticipated via projected reductions in borrowings, although there is some skepticism this will be achieved.

We have raised the up case probability by 3% and the lite down case probability drops by a corresponding 3%, but left the probabilities of the other three scenarios unchanged, as the mini-Budget’s plans are in favour of credit ratings, but only, if delivered. 

The rating agencies are likely to adopt a wait and see approach, and potentially not deliver credit rating upgrades this year. S&P’s positive outlook may be mirrored by Fitch, but the credit rating agencies will likely wait for the outcome of the ANC elective conference. 

International events remain key drivers for the rand, which did not improve much on the mini-Budget, but gained against the USD on Friday’s lift in US unemployment to 3.7% y/y. The rand should strengthen further on rising expectations of the US slowing rate hikes.

October continues to average R18.09/USD to date, with the domestic currency running around the end point reached in September. April to September saw a run on the rand, from R14.50/USD to R18.21/USD (September low), before it pulled back somewhat.  

October has been a volatile month for the domestic currency against the USD, vacillating between R17.31/USD and R18.59/USD, then gaining after the MTBPS  on 26th October, to R17.81/USD, but then weaker today at R18.40/USD.   

The US dollar lost ground last week, is strengthening today, adding to rand weakness. Last week the US saw lower than expected core PCE inflation (the key measure for the FOMC), and a higher than expected GDP figure, while the U Michigan sentiment reading held up. 

This week, the FOMC (Federal Open Market Committee) meeting comes before US payroll figures  and markets have seen some weakness ahead of the high risk events, causing safe haven flows to pick-up and so strengthening the US dollar.

A 75bp hike continues to be the consensus for this week’s 2nd November FOMC meeting, although for the 14th December FOMC meeting the possibility of a 50bp hike, instead of 75bp hike, in the Fed funds rate has been building this month. 

That is, expectations have increased over the course of this month for a 50bp, instead of a 75bp, hike in December and that this slowdown in the pace of the US interest rate cycle hike will continue, with a 25bp lift in January reaching the terminal rate.  

The ECB last week delivered a large 75bp hike in its refi rate, temporarily adding to some USD weakness, but today the greenback has run ahead, typically weakening EM currencies at the crosses, and the volatility is likely to persist into end-2022 and H1.23. 

The EU is expected to hike again in six weeks’ time, by 75bp, with the US hiking into year-end as well. Central Banks remain focused on inflation, and domestically SA is expected to see a 100bp hike in November (24th), while fuel prices are set to rise this week.  

Risk sentiment remains highly data dependent, with near-term fluctuations likely to continue, reflecting high levels of uncertainty which has caused investors to factor in a high chance of global and US recession, while Emerging Markets are expected to fare better next year.

The rand weakened today against the key crosses, at  R18.39/USD from its close of R18.05/USD on Friday,  R18.03/EUR from Friday’s R17.84/EUR, and R20.81/GBP (after closing at R20.43/GBP last week) as risk aversion levels rise globally.

Domestic factors are also contributing to rand weakness, particularly the growth negative effects of Transnet and Eskom’s inability to consistently meet demand for their services, with no immediate solutions for electricity, rail and port transport seen in 2022 or 2023.   

Ahead of the MTBPS (Medium-term Budget Policy Statement) this week Wednesday, markets have been factoring in likely assistance from the fiscus for both Transnet and Eskom, which will lower the opportunity for fiscal consolidation and so has undermined the rand.

Government is expected to absorb at least part of Eskom’s debt onto to its balance sheet in future, and while markets have been disappointed before at previous budgets (both mini and the February Budgets), government is expected to give some clarity on its plans this week.  

Transnet will also need substantial state financial assistance as it will be reportedly unable to operate profitability next year, as insufficient capacity to meet the demand for its services has eroded its earning capability as has been the case with Eskom.  

Both Eskom and Transnet suffer from insufficient repair, maintenance and replacement of working infrastructure following years of state capture which has decimated the SOE’s finances, governance capabilities and recently still have seen bulk commodities theft. 

That is, Eskom has reported theft of diesel needed to fire its open-cycle gas turbines, and Transnet has seen the loss of customers’ minerals commodities in transit and replacement with low grade commodities instead, as the stolen high grade goods are exported. 

Finance Minister Enoch Godongwana warns “Transnet presented a facade of an efficient institution, but now things begin to burst out into the open… If we don’t make an intervention, we will have another Eskom on our hands.”

Both SOE’s are vital for the functioning of SA’s economy, with markets reacting negatively to bad news in the risk averse environment, while the GBP has seen some recent strength as markets now see an improved fiscal plan versus September’s mini-budget in the UK.

The rand has reached a new weak point this year against the US dollar, at R18.58/USD, still below its historic low of R19.35/USD in April 2020, but experiencing a longer sustained period of weakness than in 2020 as US dollar strength persists.

Tightening financial conditions continue to spur risk aversion, keeping the rand weak, with policy makers expected to remain focused on quelling price inflation, crushing hopes of economic improvement and market recovery.   

US Treasury Secretary, Janet Yellen, recently stated “in the United States, our top economic priority is to bring down inflation while maintaining a strong labor market,” while recognizing that there will be “global repercussions”.

The IMF added the need for fiscal policy tightening as well, highlighting “governments should keep trimming the budget deficits they ran up in the pandemic, even as they seek to help households hit by soaring energy and food prices”.

“Global public debt is set to reach 91% of GDP this year, some 7.5 percentage points above its pre-Covid level.” “Fiscal policy should protect the most vulnerable while pursuing a tightening stance to avoid overburdening monetary policy in the fight against inflation.” 

The UK has just undone most of the proposed unfunded fiscal stimulus announced by its Chancellor’s predecessor, in a turbulent political year which has seen high levels of market volatility. The UK is now set to carry out fiscal tightening which has soothed markets.  

The IMF adds “politicians in charge of national budgets should avoid across-the-board subsidies and make sure support is targeted to those who need it most. Prioritizing policies and programs is increasingly vital as governments operate within tighter budgets.”

Next week South Africa sees its own mini-Budget, which is likely to make some strides in fiscal consolidation, but the impact of the good mini-budget this year on markets is likely to be overshadowed by the heavy risk aversion environment in global financial markets.

The rand is currently trading at R17.69/EUR, R18.12/USD and R20.49/GBP, slightly stronger than last week Thursday when a US inflation miss was published, compared to market expectations, which are increasingly factoring in a slow, lengthy fall in inflation.

The rand reached  R18.24/USD today on a continued escalation in risk aversion, the weakest point against the greenback this year, and only around a rand stronger than the historic weak point in April 2020, as the US dollar continues to climb to its high of the early 2000s.

Risk aversion elevated in 2000 in global financial markets on the collapse of the dot-com bubble, which together with 9/11 and higher interest rates, drove US recession in 2001, prompting US fiscal stimulus of major tax cuts under the Bush administration.

Y2K fears led to a boom in IT equipment purchases, stimulating the economy, which then saw a drop in stock markets in March 2000, causing the dot-com bubble to burst. At the same time, US CPI inflation rose to 3.8% y/y in March, and the core PCE deflator began increasing.

The US hiked interest rates over 2000 to seek to contain inflation, which worsened economic conditions, with the cumulative effects resulting in a US recession from March to November 2001, exacerbating market risk-off and strengthening the US dollar on safe haven flows.

Markets fear a US monetary policy misstep that aids the US  economy into recession, with risk aversion elevating since April this year on the lengthy hawkish communication from the Fed in the face of high inflation, well removed from its implicit inflation target of 2.0% y/y.   

In particular, insufficient monetary and other policy support measures are feared as Central Banks around the world are typically hiking interest rates, and plan to go past the normalisation of monetary policy to tighten it in attempt to control very high rates of inflation.    

US dollar strength continues to see the rand weaker against the US dollar than against the euro, at R17.70/EUR today. Against the British pound, the rand is at R20.18/GBP, as the UK is in the process of repairing some communication misfires on fiscal policy recently. 

Markets have become jittery into this week as the US inflation figures are set for release, with a moderation expected in both US CPI and PPI headline inflation rates for September, although excluding food and energy the measures are expected unchanged to higher. 

Core measures of inflation are key to the Fed, including the PCE deflator e. September’s US CPI excluding food and energy is expected to accelerate by 6.5% y/y, from 6.3% y/y, which has worsened risk aversion levels. A higher print risks further rand depreciation.

With the rand attempting to settle around R18.00/USD, markets await new direction as the next FOMC meeting only occurs in November, currently factoring in less than a 75bp hike for November (66bp currently), and close to 50bp in December (46bp).

The US’s interest rate hike cycle has been unusually fast and substantial, purposely so in order to attempt to quell high inflation and inflation expectations, although markets have expected that the size of the US rate hikes could reduce in Q4.22 (to 50bp a meeting).  

A week ago the implied Fed funds futures were factoring in a 70bp lift in November, higher than current market expectations, and for December 48.5%, also higher than currently for the end of the year, as market expectations have slipped somewhat over the past week.

However, the rand has not gained from the easing over the past week in markets expectations on future US interest rate hikes, with the rand averaging R18.03/USD (R17.492/EUR, R19.52/GBP) last week, versus R17.73/USD (R17.50/EUR, R19.92/GBP) the week before.

The rand has also lost ground as Eskom continues to face unresolved difficulties in increasing the availability of electricity in the face of vandalism, theft and sabotage of its infrastructure and electricity generation capacity, on old poorly maintained, or poorly built power stations.   

The newly reconfigured Eskom board did not spark rand strength, as the deep rooted problems in SA’s energy production sector are not quick or easy to resolve, but will instead take many years to repair, resolve and bolster domestic production capacity.  

South Africa has also seen a declining terms of trade since March this year as trade dynamics weakened into Q2.22 and over Q3.22, lowering economic growth expectations, along with slowing global growth (growing chance of recession) expected.

The long lead time to the advent of global recession has caused a prolonged, and worsening period of risk aversion, with this market risk-off in particular the driver of rand weakness and USD strength,  and which is not expected to ease in the near term.

While markets are factoring in a slowing in US interest rate hikes, risk aversion is at such high levels of elevation that this has not caused a calming effect, with the focus on recession risk  and its particularly slow approach, in turn exacerbating risk aversion even further.

The US dollar continues to power ahead, driven by high levels of risk aversion in global financial markets as recession fears grow. Risk assets, including equities, EM portfolio assets and EM currencies have fallen, as investors move increasingly into safe haven investments.

Bear markets loom as the Fed is seen as hiking the global economy into recession (by 2023), while the largest economic area, the EU is believed to have already fallen into recession in H1.22 and the US dollar is at multi-decade highs as market fears grow. 

Business activity has already contracted in both the EU and in the US, showing slowing economic growth for the US, and the EU at risk of contraction, with high energy prices, economic and political uncertainty and rising interest rates afflicting confidence in the EU.

With the differential between US and EU interest rates widening on rapid US interest rates, the dollar has strengthened against the euro, while US interest rate hikes are also outdoing those in South Africa, adding to both rand and euro weakness against the US dollar.

In addition, the ECB has warned that it could tighten its momentary policy (above the neutral interest rate) which will dampen economic activity for the purpose of reducing inflationary pressures, and ensuring inflation expectations do not become de-anchored.  

The World Bank warning that the risk is rising of global recession in 2023 “and a string of financial crises in emerging market and developing economies that would do them lasting harm”, amid simultaneous rate hikes has added to market fears.

The World Bank further warns that “the currently expected trajectory of interest-rate increases and other policy actions may not be sufficient to bring global inflation back down to levels seen before the pandemic”, which is also roiling markets.

But “(u)nless supply disruptions and labor-market pressures subside, those interest-rate increases could leave the global core inflation rate (excluding energy) at about 5 percent in 2023—nearly double the five-year average before the pandemic”.

The high levels of uncertainty are negatively afflicting investor confidence, in particular the long lead time up to a potential for global recession by 2023, while Central Banks hawkishness has increased again, also negatively affecting risk assets, and so the rand.

Financial markets have started to factor in more than a 75bp hike in the US, which has negatively affected risk sentiment, causing the rand to weaken towards R18.00/USD on substantial US dollar strength, with the dollar breaching parity with the euro already in August.

The Fed Funds implied rate is at 81bp for the FOMC (Federal Bank Open Market Committee) meeting this week, as markets are increasingly concerned that the Fed’s tone may become even more hawkish, with the outside chance of a 100bp hike feared.

The US monetary policy decision takes place on Wednesday, after SA market hours, and will lead the decision for SA interest rates at the MPC meeting on 22nd September. SA is not expected to hike by more than the US, and this adds to rand weakness too.

That is, FOMC members sounded increasingly unanimous about another large hike in the fed funds target rate, which was taken as signifying a September 75bp hike, but markets have now started to worry the FOMC may possibly hike for longer and even deliver bigger moves.

With the differential between US and EU interest rates widening, the dollar has strengthened against the euro, with the rand at R17.71/EUR currently, while it is trading at R17.76/USD. The rand is also negatively affected by lower growth expectations on load shedding.  

This month’s FOMC meeting will be key, as markets were hoping that Q4.22 would begin seeing lower US rate hike moves, as the Fed frontloaded its monetary policy normalisation mainly into the middle two quarters of this year.

However, global financial markets are starting to re-evaluate their expectations, which is causing uncertainty to rise, in turn negatively affecting risk assets as risk aversion (risk-off) increases. Volatility in EM currencies has increased over last week.

A reduction in FOMC hawkishness would reduce the risk-off environment somewhat while more hawkish communications than have occurred so far would increase risk aversion, and cause risk assets to weaken further, including EM currencies, and so the rand.

Should the Fed deliver a 75bp hike on Wednesday, and take a slightly more balanced tone, the rand could strengthen later in this week from current very oversold levels, which are far removed from fair value.

US CPI inflation is due for release, with markets’ expecting a second month of disinflation (falling inflation) in the print, driving some risk taking sentiment recently as the rand closed at R17.28/USD on Friday, and reached R17.07/USD today.

The US dollar is weakening in anticipation of the US headline (CPI) inflation print dropping to 8.0% y/y for August, down from 8.5% y/y, and a -0.1% m/m move in CPI, although excluding food and energy, the reading is likely to rise to 6.1% y/y in August, from 5.9% y/y in July.

While markets are taking a positive view of this week’s headline US inflation release, the Fed will, in particular, look for broadening base effects, which the CPI excluding food and energy is likely to show, and so the recent dollar weakness/ rand strength risks being temporary. 

With the US CPI figures released tomorrow afternoon there could be space for the rand to strengthen in the interim. However, overall the rand is still very weak, well removed from fair value and still reflective of an elevated risk aversion environment, despite some volatility.

The rand is likely to fluctuate, weaker and stronger, for the remainder of this month and into Q4.22, retaining high sensitivity to any and all US inflation figures, but key for the Fed remains the core PCE deflator. Q4.22 may bring increased possibility of rand strength however. 

This week, markets will react directly to the US CPI figures, influencing the US dollar and so the rand. Currently the Fed funds futures rate shows a 73bp hike is factored in by markets at the FOMC meeting this month (on 21st September), essentially factoring in a 75bp move.

Market expectations for September’s US interest rate move have been fluctuating, closer to between 50bp and 75 earlier in the month, and a lower than expected CPI print tomorrow could see the market move its rate hike view back closer to 50bp if this occurs.

The rand could see further strength against the greenback on such an eventuality as the US dollar weakens a bit further, but this short-term volatility risks being overrode by the PPI print coming out higher than expected later in the week, or any following inflation indicator.

Volatility is likely to persist for the rand against the US dollar, while it has experienced greater stability against the GBP and EUR. However, over Q4.22 it may well see some more fundamental strengthening, drawing towards R16.00/USD instead of R17.00/USD. 

The US dollar continues to run close to parity against the euro, with the rand’s exchange rate  versus the dollar and the euro very similar. Indeed, the rand is unusually slightly stronger against the USD than EUR, on the lengthy risk-off environment in global financial markets.

Today the domestic currency is back above R17.00 to the USD (and the EUR), reaching R17.42/USD (and R17.23/EUR) from R16.86/USD (R16.85/EUR) a week ago, with risk aversion exacerbated in global financial markets by Friday’s US jobs data prints.

Financial markets reacted negatively to the ongoing strength in US labour markets, with the addition of new workers to the payroll (non-farm) system seeing a higher than expected jump, to 308 000 in August (298 000 expected), but still very low unemployment.  

At around 3.5%, the US unemployemt rate was at a five decade low just before the pandemic in February 2020, returning to this level in July, and only showing a modest uptick to 3.7% in the figure released for August on Friday. 

The Fed will still be concerned overall on the tightness of the US labour market, although hourly earnings subsided slightly to 0.3%, from 0.5%, while the actual pace of hiring also slowed, as non-farm payrolls rose by 528 000 in July (versus August’s 315 000). 

While the jobs data was slightly mixed overall, markets have now settled lower in terms of factoring in expectations on the next hike in the US’s Fed funds rate  - the decision between 50bp or 75bp at the upcoming FOMC meeting this month on the 21st.

That is, a 64bp as opposed to 67bp hike in the fed funds rate is now factored in by the implied Fed funds futures, still closer to 75bp than 50bp however, and so adding to the risk-off environment and safe haven flows.

While the Fed has taken an optimistic tone on economic activity, and retained  a hardline in communications against inflation, the markets are still worried about future economic activity, particularly a sharp slowdown in production, and so a contraction in the economy. 

The rand is likely to remain volatile and tend towards weakness in the remainder of the quarter, but markets also traditionally see greater risk taking into, and during Q4, and risk appetite could pick up somewhat towards year end if market fears prove overdone on GDP. 

The rand has continued to digest Fed Chair, Jerome Powell’s speech at the Jackson Hole conference on Friday, which saw the focus remain on bringing US inflation back to target, and the rand move similarly to its reaction last week on the release of the FOMC minutes.

Indeed, the domestic currency, which reacts negatively to events that are seen to increase risk aversion in global financial markets, saw slightly less depreciation in response to Powell’s Jackson Hole speech, than last week’s release of July’s FOMC meeting’s minutes.

Some evidence of slowing economic activity in the US did not sway the Fed Chair’s view that the FOMC “overarching focus right now is to bring inflation back down to our 2 percent goal” and “(r)educing inflation is likely to require a sustained period of below-trend growth.”

“Restoring price stability will take some time and requires using … tools forcefully to bring demand and supply into better balance. While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses.” 

The US dollar strengthened, driving the rand to R17.00/USD today, from R16.70/USD on Friday before the Fed’s comments, but is at its Friday close against the euro at R16.81 and against the British pound at R19.71, slightly stronger than Fridays’ close of R19.82. 

Jerome Powell added that “in my view our economy continues to show strong underlying momentum. The labor market is particularly strong, but it is clearly out of balance, with demand for workers substantially exceeding the supply of available workers.” 

Markets drew some confidence from these positive remarks, which were taken to signify that the US economy was not close to recession, and that the Fed was keeping close watch, although higher interest rates were still likely and taming inflation remained key.

The Fed worried that “high inflation has continued to spread through the economy. While the lower inflation readings for July are welcome, a single month's improvement falls far short of what the Committee will need to see before we are confident that inflation is moving down.”

Powell did not give a clear view on whether the next FOMC meeting would see a 50bp or 75bp rate hike, and markets have left the door open for either, factoring in a 68bp lift, slightly up on a few weeks ago, but not at the full 75bp, and likely to fluctuate. 

The rand breached R17.00/USD on Friday, losing ground over the course of last week against the US dollar as global economic growth concerns rose, while the dollar moved back to parity against the euro. The rand is now at virtually the same rate against the USD as EUR.

That is, the rand is trading at R17.06/USD and R17.06/EUR, with the USD and EUR essentially valued equally following the dollar’s run of strength last week, which accelerated in particular in the second half of the week on the publication of the US FOMC minutes.

Against the euro, the rand has seen milder depreciation, but still apparent, as perceived risk assets such as equites, EM portfolio assets and EM currencies have weakened, along with commodity prices, as risk aversion has increased in global financial markets.

Economic growth forecasts have become more negative across the board as the risk of global recession is seen to have risen, while slower global growth is seen as very likely, particularly on higher interest rates due to inflation concerns.  

The global inflation surprise, as the IMF puts it, means global inflation has come out much higher, and persisted for longer, than was widely expected this year, with the US initially slow to hike interest rates, along with a number of other advanced economies.

Supply chain constraints have not been overcome, nor have other supply side cost pressures, and the outlook has weakened, particularly over 2023, as Central Banks focus on tightening interest rates to avoid broad based inflationary pressures from becoming entrenched.

However, risk assets focus particularly on growth expectations. Higher global interest rates, which are intended to slow economic growth, and so demand, materially, have a negative effect on the expected returns of risk assets, and so on the assets themselves.

The FOMC minutes released in the middle of last week, but for the July meeting, already showed the FOMC was aware of the weakening in US activity, but also that the focus remained on controlling inflation, and so a further increase/s in the US rate hike cycle. 

The US dollar has consequently strengthened, buoyed also by increased safe haven flows into the US, weakening the rand against the USD; but there is also an element of outright rand weakness, which has occurred on investors increasing their switch out of risk assets.

After strengthening to R16.16/USD by Friday, the rand has weakened somewhat, to R16.40/USD today, remaining influenced by international data releases, with weakness from China’s economy apparent in July on the effect of its zero COVID policy restrictions.

With China the world’s second largest economy, a skew towards weaker growth outcomes as inflation has been slow to subside globally, if at all in some areas, has seen market risk aversion lift at the start of this week. High data sensitivity is likely to persist this year.

The rand is at a weak level above R16.00/USD, and is likely to strengthen below R16.00/USD by the end of this year. It currently averages R16.75/USD for the first half of Q3.22, but likely to drop down towards R16.00/USD, if not stronger by the end of this quarter.

The second and third quarters of the year tend to be risk averse quarters for global financial markets, while September/October usually sees increased risk taking, which benefits the rand and other EM currencies, as well as EM portfolio assets, and other risk assets.

That is, the rand tends to strengthen in the fourth quarter of the year as key market players reposition for higher risk/reward, while the middle two quarters are usually weak quarters for the rand on thin market trading which exacerbates sensitivity to risk. 

The volatility of the rand is still lower than a number of other EM countries, running closer to the middle of the Bloomberg basket than at the high end as it did in Q1.22, and generally EM currency volatility is higher than they were in Q1.22, reflecting elevated risk.

The risk is tilted towards slower economic growth this year, particularly in Q4.22 and H1.23, and this could see the rand not make as markedly  substantial gains as it usually does in the first and last quarters of the year on seasonal influences.

There is increased global synchronisation on interest rate hikes (and acceleration in these hikes), which is adding to risk-on in financial market sentiment on global growth concerns, and so the current heightened risk sensitive environment. 

Uncertainty heightens risk aversion, which has added to the momentum in the rand’s depreciation from R14.53/USD at the start of Q2.22, to a weak point of R17.26/USD a few weeks ago. The rand is expected to see strength into, and over Q4.22, but risks remain. 

The rand remains influenced by international growth concerns, with the possibility of recession still spooking markets, and monetary policy authorities continuing to hike interest rates,  tightening financial conditions in the face of high inflation.

While Q2.22 Eurozone growth surprised on the upside, H2.22 is not expected to repeat this, and markets have been factoring in these weaker expectations, not just for the Eurozone, but globally, supporting safe haven flows and USD strength.   

Elevated levels of uncertainty create risk aversion, and risk-off in financial markets is elevated “The magnitude of the inflation surge has been a surprise to central banks and markets, and there remains substantial uncertainty about the outlook for inflation” (IMF).

The IMF adds “inflation risks appear strongly tilted to the upside. There is a substantial risk that high inflation becomes entrenched, and inflation expectations de-anchor.” Markets fear the persistence of a harsh interest rate hike cycle this year and into next.  

This has caused a notable withdrawal from risk assets over both Q2.22 and Q3.22, resulting in USD strength on safe haven inflows, and weakness in commodity prices and EM assets; and so the rand, which is both a commodity and EM currency.

The volatility of the rand is lower than a number of other EM countries, running closer to the middle of the Bloomberg basket than at the high end, but overall volatilities are higher for EM currencies than they were in Q1.22, reflecting elevated risk.

The IMF notes second round effects are occurring as consumer price inflation for services, and indeed “everything” from housing rents to personal services, are picking up from already elevated levels, and are unlikely to come down quickly.

Warning ”these pressures may be reinforced by rapid nominal wage growth. In countries with strong labor markets, nominal wages could start rising rapidly, faster than what firms reasonably could absorb, with the associated increase in unit labor costs passed into prices.” 

The rand will remain at risk over Q3.22, with the third quarter of the year typically the weakest period for the rand as risk aversion levels tend to be elevated on thin trade as market players tend to withdraw from riskier investment to take vacation.

The rand strengthened to R16.47/USD last week (R16.81/EUR, R20.08/GBP), as the USD dollar weakened to 1.03 to the EUR. The recovery came in the wake of the FOMC’s less hawkish tone for interest rates at the end of this year and next year on Wednesday night, followed of Friday by positive news out of the Eurozone showing quickening economic activity in Q2.22 despite the effects of the Russian/Ukraine war. Other currencies also notched up small gains against the USD as safe haven flows eased.

European GDP remains resilient in the face of high food and energy price inflation and supply chain issues.  The removal of most Covid-19 lockdown restrictions in the Eurozone in H1.22 saw a quicker than expected acceleration in GDP growth, to 0.7% q/q against market expectations of a 0.2% q/q outcome, and 4.0% y/y versus an expected 3.4% y/y (Q1.22 0.6% q/q, 5.4% y/y). France, Spain and Italy led the growth over Q1.22, with Germany seeing activity halt, as Q2.22 recorded no improvement over Q1.22. France, in particular, benefited from tourism, up 0.5%. Spain and Italy saw 1.1% and 1.0% (expected 0.4%, 0.3%) respectively. Furthemore, increased fiscal support to aid in households is tempering the effect of high inflation. The region has seen some cuts to energy (natural gas) supplies, but also lower gas prices. Better prospects for the euro bloc’s growth saw the euro tracking back from parity with the dollar in mid-July, and then rising further after the rate hike.

Locally, the outcomes of the ANC policy conference, including a decision to maintain the "step aside" rule for those facing criminal charges, were positive for the rand. Markets were encouraged by party support for Ramaphosa’s proposals, which bodes well for his reelection in December, and the adoption of market-friendly policies should benefit the domestic currency. However, the rand is still far from R14.40/USD in March this year, when the dollar was particularly weak.

The rand has strengthened to R16.71/USD, from R17.26/USD last week, with SA’s 75bp hike matching June’s FOMC’s move, and the MPC’s very hawkish tone bolstering expectations that the SARB will not let SA’s interest rate differential with the US narrow severely.

The FRA (Forward Rate Agreement) curve did not fully factor in a 75bp hike at last week’s MPC meeting, and as a consequence the rand has had room to strengthen significantly as markets digested the information from the meeting, and in particular the very hawkish tone of the SARB.  

Markets will continue digesting the MPC outcome this week. The domestic currency has room to strengthen even further, although much will depend on the signals coming out from the US, with the latter likely to have a strong impact on the rand.

SA’s FRA curve currently anticipates that the SARB will only hike the repo rate by 50bp  in September, while the November meeting is expected to deliver a 50bp hike but with a greater chance of 75bp.

The FOMC meets this week and is expected to deliver a 75bp hike on the 27th July, which is  fully factored in by the Fed Funds Futures. However, this will take the US lift in the cycle to 2.25%, while SA is at 2.00% currently, as SA saw a 75bp not 100bp hike last week.  

The differential between SA and US interest rates will consequently risk narrowing at the end of this week, causing some pressure on the rand. The US dollar has weakened somewhat ahead of the FOMC meeting, now at 1.02 dollars to the euro from parity earlier in the month.

Risk aversion has subsided slightly, allowing the US dollar to lose some ground, with markets having pulled back somewhat, as recent US data showed some slightly better outcomes on the activity and inflation front than expected, although the pull back is relatively small.

The US’s strongly positive Empire State Building Manufacturing Survey on general business conditions for June (released 15th July) cheered markets, contrary to expectations of a negative outcome. US retail sales were also market positive.

The value of the rand is highly sensitive to international events, particularly those taking place in the US, and the better than expected US data recently has slowed flows to the US dollar, which is perceived as a safe haven.

The rand is at 17.03/USD (from R16.97/USD on Friday), with USD strength bringing it close to the R17.17/EUR rate, as the euro is essentially at parity with the US dollar. Negative sentiment on both international and domestic events is not assisting the local currency.

Foreigners remain net sellers of SA government bonds this quarter so far, with net flows of -R0.1bn. On two days alone last week, -R4.3bn was sold, versus -R3.6bn over the whole of Q2.22.

The second, and particularly third, quarters of the year are usually weak periods for the rand as senior traders in risk assets, including EM currencies and portfolio instruments, tend to go on vacation in the peak summer months.

Market worries over high inflation are being increasingly replaced by fears of excessive interest rate hikes, driving economies into recession, and risk sentiment in global financial markets is fragile and significantly risk averse.  

Friday’s publication of the higher than expected US payroll figures and low unemployment rate, static at 3.6%, have spiked market worries for continued severe US rate hikes over H2.22: a further 175bp lift, according to the FOMC member predictions.  

The markets are expecting a 185bp lift and so are fairly aligned to the FOMC communication. But market players worry that the anticipated rate hikes, which will take the fed funds rate well above its neutral level, will dampen economic growth.

Domestically, severe load shedding has dented SA’s growth prospects, which in turn risks negatively impacting state revenue receipts. The harsh stage 4 and 6 electricity outages have damaged business productivity, while the extreme pressure unions brought to bear on the state owned electricity utility (Eskom) is seen as negative from a political as well as economic perspective. Investors are likely to be spooked even further in the run-up to the 2024 ANC elective conference, which has raised the political noise in SA generally, with the state capture faction of the ANC (often known as the RET) taking every opportunity to smear the reputation of the current president.

After weakening to R16.50/USD by the end of last week, as severe load shedding persisted on the back of the Eskom workers’ strike, the rand has pulled back to R16.25/USD today, although also afflicted by global financial market risk sentiment.

Stubbornly high inflation saw key Central Banks turn very hawkish in their communications, and a sharp downwards revision in global, and US, growth forests from mid-April caused a sharp drop in risk asset prices (including equities, and EM assets and currencies).

Q3.22 is still at risk of marked weakness, both for the rand and for all risk assets, with lower liquidity levels in global financial markets as there is seasonally less trading activity in financial markets in the Northern Hemisphere summer months.

That is, with the bulk of global wealth held in the Northern Hemisphere, and senior traders typically winding down risky positions in Q2.22, taking vacation in Q3.22, the very thin markets typically exacerbate risky events, increasing risk-off investor behaviour. 

The rand, and risk assets, typically see greater weakness in the middle two quarters of the year, and greater strength in the first and last quarters of the year, with the rand driven mostly by factors affecting global financial markets, with April’s weakness not unusual.

While seasonal effects have an influence on the rand, so do fundamental factors. With obdurately high inflation in the US and EU (with Euro-area CPI inflation now at 8.6% as well, jumping higher from 8.1% y/y in May), interest rate expectations are rising.  

Increased sanctions on Russia are expected to further push up oil prices towards the US$200/bbl barrel, and if very severe, possibly towards US300/bbl, which is worrying markets, and adding to risk off sentiment, as uncertainty negatively affects risk sentiment. 

With the Russian/Ukraine war showing no signs of coming to an end, and continuing to negatively affect energy and food commodity prices, high inflation is expected over H2.22, and into H1.23, with high inflation also damaging consumer confidence and real spend.

The US has been adamant in the need to suppress high inflation, and is currently likely to increase the fed funds rate to 3.00-3.25% by year end (if not 3.25/3.50), from its current 1.50-1.75% range,  which is worrying markets, and adding to risk-off sentiment.

With the rand averaging R15.59/USD so far this quarter, and only four readings left, the domestic currency is likely to attain its forecast (average) rate for Q2.22, while it is now tracking towards R15.80/USD, its Q3.22 forecast.

However, Q3.22 is still at risk of marked volatility, despite some recent strength in the rand. While the domestic currency reached R15.77/USD today, before being rebuffed back towards R15.90/USD, it has yet to sustainably breach the R15.80/USD resistance level.

The rand has gained from its geographical distance from the Russian/Ukraine conflict, and from Europe in general, as well as from portfolio disinvestment from China, with China seen as aligned with Russia, and having increased imports of Russian energy commodities. 

China has led EM non-resident portfolio outflows since the Russian/Ukraine war, while overall foreigners have been net disinvestors from EM portfolio assets, as higher interest rates (particularly in the US) and high inflation globally has driven recession fears and risk aversion.

By the end of May, there was some evidence that the outflows had lessened, but investor sentiment has been volatile, and the volatility is likely to continue for emerging markets this quarter and next; and increased risk of US recession will heighten this. 

While the US monetary policy committee has been very positive about the strength of the US economy, it is increasingly believed that a marked slowdown, and weakness in the labour market is needed to bring inflation sustainably back to the FOMC’s goal of around 2.0%.  

The Fed has yet to show notable concerns on the strength of the labour market and US economy, but markets are a lot less sanguine, which has driven risk aversion sentiment and so the weakness in risk assets, particularly those of EMs’ and their currencies.

Signs of an extensive slowing in the US economy are likely in H2.22, which should limit US interest rate hikes, while the global economy is also expected to slow, causing interest rate hike expectations to likely be scaled back in other key advanced economies too.

While initially positive for the rand, which would likely see further weakness if the US continued to deliver large interest rate hikes this year and next, the domestic currency will also remain volatile, and at risk of particular weakness on global recession.

With recent US CPI data surprising on the upside, Thursday’s 75bp hike was built into expectations for the Fed’s fund rate. The rand saw little sustained reaction, hovering around R16.00/USD, and remaining on track to average R15.60/USD this quarter.

The US interest rate move reinforces the likelihood of a 50bp hike by the SARB in July, although SA’s FRA curve is now factoring in an even larger hike when the MPC meets in July. So far, markets have built in 66bps as they start to lean towards 75bp. Currently, we continue to expect a 50bp lift in SA’s repo rate, with the SARB likely to follow the direction, but not necessarily the quantum of moves of the FOMC, which has hiked in consecutive 25bp, 50bp and 75bp tranches so far this year. 

The FOMC warns that “the current picture is plain to see: The labor market is extremely tight, and inflation is much too high... it is essential that we bring inflation down if we are to have a sustained period of strong labor market conditions that benefit all.” This follow's the Fed's May note that “there was a broad sense that a 50bp change should be considered at June’s meeting but inflation has again surprised to the upside, inflation expectations have risen, and projections for inflation this year have been revised up." The FOMC is particularly concerned that a wage-price spiral is developing: “the labor market has remained extremely tight, with the unemployment rate near a 50-year low, job vacancies at historical highs, and wage growth elevated”, while lowering its GDP projections.

The implied rate in the financial markets for the July FOMC meeting is now just above 70bp, with the very hawkish commentary from the Fed aligned towards further large rate hikes. The dot plot shows a further 175bp in US rate hikes in H2.22. Should US inflation not turn the corner and begin sustainably subsiding, the pressure on US interest rates could drive further financial market risk-off, and raises the spectre of a mild US recession over the turn of this year. But that seems to be a risk the Fed is willing to take. Continued aggressive moves to stamp out high inflation, despite possible weakness in the labour market and the US economy, portend poorly for the rand.

The rand is on course to average R15.60/USD this quarter, with inflation outcomes surprising markets on the upside, as US CPI inflation rose to 8.6% y/y in May, showing the peak did not occur as markets hoped for in April, raising investors risk aversion levels.

The US dollar has strengthened against the Euro, now at 1.0476 as it pulls toward the 1.04 mark, from 1.08 at the end of May, with the spread closing between the rand against the USD and EUR, at R16.04/USD and R16.80/EUR respectively.

A year ago the rand was trading at R13.78/USD and R16.70/EUR respectively, with the US dollar at 1.21 to the euro, and with the dollar having weakened to 1.22 to the euro already at the start of June 2021, when risk aversion levels were particularly low a year ago. 

With the US dollar, and in particular US treasury’s, seen as a store of safe haven for turbulent times, global financial market fears of high inflation, low growth, and particularly rising inflation/falling growth, have reinforced stagflation concerns.

Volatile market sentiment is once again beginning to worry over the potential for a 75bp hike  in the US’s fed funds rate instead of a 50bp hike as the FOMC meeting on the 15th approaches, or if not then, then potentially on the 27th of July instead. 

Market sentiment is running on the latest data from the US on a daily/weekly basis. US PPI inflation figures are due tomorrow and while expectations are for a drop in producer price acceleration, to 10.8% y/y from 11.0% y/y, the risk for markets is a higher print. 

Retail sales figures are due in the US along with import price inflation (expected at 12.2% y/y for May after April’s 12.0% y/y) on Wednesday, both before the FOMC meeting that evening, with the retail sales data also yielding retail price inflation insight. 

The closely watched PCE deflator of the FOMC in its monetary policy deliberations is due at the end of this month, at 6.3% y/y previously and the more important core reading at 4.9% y/y. Market worries are likely to grow towards month end of further inflation elevation.

FOMC members have been convinced of the extremely robust nature of US economic growth, and as such the tone at this week’s FOMC meeting is likely to remain significantly hawkish, which would place further pressure on the rand this week.

The rand has strengthened in June, after May’s sharp run weaker, with the domestic currency at R15.31/USD today, from an average of R15.89/USD over May, and a high of R16.37/USD. Global financial markets subsequently saw risk aversion lesson from mid-May onwards.

USD strength has subsided somewhat, but the rand has also gained against the Euro, at R16.41/EUR today, from an average of R16.80/EUR over May, and a high of R17.18/EUR in that month. The euro reached 1.08 in June against the US dollar, from its 1.06 May average.

The rand has also gained against the other crosses too, and is now at R19.21/GBP, from May’s average of R19.79/GBP and high of R20.12/GBP. Markets have calmed after episodes of marked risk-off that were driven by fears of a very rapid US rate hike cycle. 

Market expectations for US rate hikes have cooled, with a 50bp hike expected on the 15th of this month, and another next month on the 27th for the Fed funds target rate, although after that markets still expect another 100bp by year end.  

Markets cheered recently as well on the inflation front as OPEC+ agreed to increase production significantly over the next two months, potentially to the point which overcomes the shortages in the energy market caused by the sanctions against Russia.  

Saudi Arabia has led the agreement, which is a move away from its controlled supply policy of the past few years. The eurozone has already seen producer price inflation at a record high in April of 37.2% y/y (March 36.8% y/y), driven by food and beverage prices. 

In the US, higher than consensus jobs numbers on Friday (at 390 000 versus expectations of 318 000) saw some recession fears recede, while the unemployment rate remained at 3.6% (consensus) providing the outcome that gave markets some reassurance.    

The Bureau of Labor Statistics reported 80 000 jobs were created in the US’s hospitality and leisure sectors, while professional and business sectors added 75 000 and transportation and warehousing 47 000, while retailers shed a reported 61 000. 

With the jobs numbers fairly broad based, evidencing continued strength of the US economy, while US inflation excluding food and energy is expected to dip this week from 6.2% y/y to 5.9% y/y for May, markets are seeing the combined outcomes as positive.

Markets have continued digesting the FOMC minutes, cheering further on the reading of the US economy, which “all participants concurred … was very strong”, and on growing optimism for a quick bounce back in Q3.22 for Chinese economic activity as its COVID cases collapse.

Lockdowns are easing in China and expected to end over Q3.22, allowing the world’s second largest economy to recover, while appetite for its zero-covid policy is waning and divergence is emerging politically on support for the onerous regulations.

The relative mildness of the Omicron variant, and easier levels of restrictions globally, have also boosted optimism, and markets are fretting somewhat less about the severity of US rate hikes as the FOMC reiterated its broad based approach.

Specifically, FOMC members “concurred that their assessments would take into account a wide range of information, including readings on public health, labor market conditions, inflation pressures and inflation expectations, and financial and international developments."

The domestic currency is not yet expected to run back below R15.00/USD this quarter

Currently, markets appear to be placing their trust in the Fed’s ability to bring inflation down without landing the US in recession, and indeed inflation expectations for the US are starting to tip lower, adding to the reduction in risk-off sentiment.

The second quarter of the year is however often very volatile for markets, with the rand often experiencing market weakness, as well as some recovery at times, and the domestic currency is not yet expected to run back below R15.00/USD this quarter.

We recently raised the up case probability by 2% on the positive outlook for SA from S&P, dropping the expected case and lite down cases by 1% each. S&P’s positive outlook has also reduced the rand’s volatility, along with support from some commodities.

However, the rand will remain at risk this quarter and next, given that it is largely determined by international events, and evidence of weak US economic data would provide a particularly negative impact if inflation is slow to subside, unless the FOMC slows its rate hikes.

Global financial markets are in a risk-off phase on fears of a severe slowdown in world economic growth, potentially to the point of recession, causing investors to sell off risky portfolio assets from mid-April.

The rand has run weaker for over a month, when it left the R14.00/USD to R15.00/USD range in April, running closer to R16.00/USD, although benefitting recently from the S&P positive outlook for SA’s credit ratings on domestic factors, allowing the domestic currency to track back to R15.65/USD.

A widening interest rate differential between SA and US interest rates would place the rand at greater risk of depreciation than has already occurred

However, globally the outlook has not improved, and the IMF warns that the world’s economy faces “the biggest test since the second world war.”

“The global economic outlook has darkened in the month since the IMF downgraded its 2022 growth outlook because of the war in Ukraine, China's slowdown, and global price shocks, particularly for food”.

A global recession is not seen as the central case, but the IMF added that it cannot be ruled out, which is adding to the negative sentiment. The IMF also recommends that “the Fed must continue to tighten monetary policy to get control of a surging inflation rate in the US” and that “it’s very important for the Fed to rein in inflation as soon as possible”.

Increased global financial market risk aversion has been generated by expected significantly tighter financial conditions, in the face of high inflation, driving fears of weakened world growth.

The IMF adds, “inflation in the US is broad-based.”

“This is not all a supply story. There is an important demand component to it.”

The US “should not take their eye off the ball.” A widening interest rate differential between SA and US interest rates would place the rand at greater risk of depreciation than has already occurred, which in turn would place pressure on SA’s inflation outcomes.

Global financial markets have turned more severely risk off, driven by a number of factors, but chiefly that the typical risk averse period of the middle two quarters of the year (northern hemisphere summer period) coincides with the severe tightening cycle of the US.

Global growth concerns have come to the fore, not just the effects of the severe interest rate  hikes in the US, on both US and global growth, but also the surge in COVID-19 infections in China, and resultant lockdowns, and the increase in sanctions against Russia.

The annual sell (risk assets)-in-May and-go-away (typically from risk asset trading) has exacerbated market sensitivity (typically increasingly thinner trading over Q2 and Q3), and the rand has increasingly weakened since the second half of April. 

Foreigners have been net sellers of SA equities, of -R26.7bn, respectively (net of purchases) from the second half of April to date (JSE trading data), which has weighed on the rand, while settled data shows only R2.8bn in net bond purchases (Bloomberg and the JSE).

The JSE has dropped to 67 978, from 78 297 in March, while the MSCI emerging market bond index has tracked down since early April after some strength earlier in Q1.22, and then recovery in March from the impact of the start of the Russian/Ukraine conflict. 

However, foreigners are substantial sellers of EM portfolio assets, particularly China, and this has caught up with the rand too over April. Commodity prices fell over April, also subduing the rand,  particularly for metals prices.

Resource counters too cooled over the period, with this section of the JSE instrumental in its overall moderation. Coal prices are still elevated, a key export but SA is facing huge challenges meeting export demand, and stockpiles are growing for bulk exports.

Indeed, rail deterioration has seen Transnet cancel long-term railing agreements for coal exporters reportedly under force majeure as the entity has been unable to overcome the damage from cable theft, inability to obtain locomotive spare parts and other issues. 

The April floods in KZN will also have damaged the currency’s performance as it hit exports in that province, and in general foreign investors sentiment towards SA has been dulling. The rand has disassociated from the strong EM currencies’ pack it was in earlier in the year.

So far this quarter, the rand averages R15.08/USD, weakening substantially over the second half of April as markets increasingly worried that the US would hike its interest rates significantly more than SA in Q2.22, and H2.22.

Tomorrow night’s (SA time) FOMC meeting will be a key determinate for the domestic currency, with a 50bp hike in US interest rates factored in by the markets, although there are some worries of a 75bp hike instead, which have driven the rand particularly weaker recently. 

While a 50bp lift is most likely, the FOMC sees another meeting next month (June) to asses, and change, monetary policy yet again, and markets have factored in another 50bp hike in June, and indeed two more at the FOMC’s July and September meetings, a 2% lift in total.   

SA in comparison only has three monetary policy meetings in the period, and markets do not expect the same trajectory of rate hikes, with just under a 50bp hike in the repo rate anticipated this month (88% chance of a 50bp hike.)  

In fact, financial markets have fully factored in a 250bp hike in the fed funds rate by year end, while  in SA just under a 2.00% hike in the repo rate is expected from here this year, less than that of the US which would narrow the differential between SA and US interest rates. 

Such an outcome typically results in rand weakness, and the rand is likely factoring this in ahead of time. Additionally however, a 2.00% lift in SA’s repo rate in the remainder of this year would be negative for economic growth.  

Commodity prices have moderated, and are expected to drop further as global economic growth expectations have weakened for 2022, and the coal price (SA’s leading export this year) is significantly lower than two weeks ago.

The second half of April also saw a negative impact to SA’s trade balance from the extreme floods in KZN and disruptions to exports, which would have had a negative effect on the rand, at the same time as the market concerns over FOMC hawkishness elevated.

The sell-in-May and-go-away adage for financial markets refers to the advent of the Northern hemisphere summer vacation period, and also adds to risk aversion and so typically some EM currency weakness, along with other perceived risk assets. 

Emerging markets across the board have tumbled over the past couple of weeks on a number of factors, including the increasingly hawkish commentary from the Federal Reserve Bank, with the exception of Russia’s ruble, which is receiving support from its government.

The domestic currency is over a rand weaker, having given up trying to remain below R14.50/USD after the first half of the month and now instead is running closer to R15.50/USD as May, and the traditional seasonal higher risk averse period, approaches.

The negative impact to SA’s trade balance over April from the extreme floods in KZN and disruptions to exports, will have had a particularly negative effect on the domestic currency, along with lower commodity prices. The large trade surplus has been a key rand support.

Q2.22 is likely to continue to see the rand removed from the R14.50/USD mark, with April so far on average recording R14.84/USD, and likely to average close to R15.00/USD for the month as a whole as most commodity prices prove weaker in Q2.22 than in Q1.22. 

Global growth is expected to be weaker this year than was initially expected in January on the effects of the Russian/Ukraine conflict, severe lockdowns in China and stringent US monetary policy normalisation path dim economic prospects, and those for commodity prices. 

Both the World Bank, and the IMF have cut their global growth forecasts, by close to 1% y/y for 2022, with the World Bank warning last week that “clouds have gathered over the economic horizon, which will mean lower economic growth and higher poverty.”   

The IMF, also at the start of last week, bleakly said “global economic prospects have worsened  significantly since our last World Economic  Outlook forecast in January. Overall risks to economic prospects have risen sharply”.

Both multilaterals also expect slower global growth in 2023 than was previously forecast, with the IMF worrying “(t)he economic effects of the war are spreading far  and wide—like seismic waves that emanate from the  epicenter of an earthquake”.

With a gloomy start to the post Easter week for markets the rand has weakened materially, although it will likely stabilise into month end once markets have digested the recent slew of risks. Currently, we still expect the rand to average R15.20/USD this quarter.

The rand remains one of the leading EM currencies, both since the start of the year, and over the past twelve months, benefiting from the differentiation between commodity exporters and importers, early and late cycle rate hikers, credit rating metrics and foreign portfolio flows.

The rand continues to be rebuffed from sustainably piercing the key resistance level of R14.50/USD, with the domestic currency relatively stable otherwise, trading between R14.53 and R14.82/USD this month,  having only briefly pierced R14.50/USD at the end of March.

The rand’s strengthening trend since the start of last year has stalled at the major level, mainly afflicted by the moderation in commodity prices over the last month, but has not lost much support and is showing a degree of relative stability, which is positive for Q2.22.  

Q2.22 is currently likely to see the rand slip further away from R14.50/USD, on average recording around R14.95/USD, as most commodity prices wane further over the second quarter, although this is also likely to be uneven as some commodities lead others. 

Commodity prices are not expected to collapse outright in the second quarter however (base case), and so the rand should avoid severe volatility, instead likely moving towards R14.70/USD mid-month, and towards R14.80/USD around month end. 

The probability of this expected case at 51% runs against a downside, of 46% (lite and severe down case probabilities), with the lite down case probability reducing this year so far as the credit rating agencies became noticeably less negative against SA.   

With the Russian/Ukraine conflict waxing and waning, and SA well removed from any credit rating upgrades yet on a number of weak fundamentals for economic growth, the rand is still at risk of severe weakness (even if less so after the removal often negative rating outlooks). 

There is uncertainty consequently too, but we nevertheless expected less rand volatility this year (see expected case forecasts) than last year, and certainly the year before, and over the medium-term as the slow progress of the repair of SA’s state productive capacity persists. 

This week US inflation will be in focus, with CPI tomorrow and PPI Wednesday, likely to reflect early March and late February commodity price highs, although we continue to expect Q2.22 will see US inflation moderate on base effects, and more modest commodity prices.

The commodity rally has bolstered South Africa's economic outlook with the rand proving to be one of the most resilient emerging market currencies this week. These improved domestic metrics have upped the probability of an expected base case playing out in the country by 3% YoY to 51% on Investec's list of possible economic scenarios; while the potential for the lite down scenario has fallen from 44% in Q1 2021 to 40% in Q1 2022.

The last time the divergence between the two scenarios was so great was in 2018 on the back of Ramaphoria, and the last time the expected (base) case was at or above 50% was in 2013.

Investec's economic scenarios range from an extreme up case (1%) to an up case (2%), a base case (51%), a lite down case (40%) and a severe down case (6%).

What is the expected (base) case for the South African economy?

• Recovery from the sharp global economic slowdown by 2024 in real terms: global and domestic monetary and other policies support growth in financial markets; risk sentiment is neutral to positive.
• Exproproation of private sector property is limited and does not have a negative impact on the South African economy or on market sentiment.
• SA remains in the BB category rating bracket thanks to fiscal consolidation (debt to GDP stabilisation).
• Civil and political unrest wanes.
• Inflation impacted by normal course of weather patterns via food price inflation 
• Modest transition to renewable energy and slow move away from fossil fuel useage. Measures to alleviate the impact of climate change on the economy are modestly implemented.

South Africa has seen a recent halt in credit downgrades, with both Fitch and Moody’s removing the negative outlooks on SA’s credit ratings in place since 2021.  

Fitch removed its negative outlook in December last year, citing “strong fiscal performance … and significant improvements to key GDP-based credit metrics following the re-basing of national accounts... A major re-basing of national accounts has meant that 2020 nominal GDP was 11% higher than previously reported, affecting key credit metrics including GDP per capita and government debt/GDP, which for FY20/21 now stands at 72.2% rather than 81%... Fiscal indicators have also improved, supported by the economic recovery. The strong deficit reduction (is) well above earlier expectations, driven in part by a surge in commodity prices“.

Fitch does not publish a calendar of its country review dates for SA.

In addition to the factors highlighted by Fitch, Moody’s noted that, over the past two fiscal years, government re-prioritised its spending, demonstrating commitment to fiscal consolidation, which the rating agency expects will remain the case.

Moody’s can change/affirm ratings/outlooks at or between scheduled dates, or not at all.   

Investec's economic scenarios explained

What is the lite (domestic) down case?

• The international environment (including risk sentiment) is that of the base case.
• South Africa fails to see its debt projections stabilise and falls into single B credit ratings from all three agencies for local and foreign currency.
• Recession occurs.
• Very limited expropriation of private commercial sector property without compensation, with some negative impact on the economy.
• Business confidence depresed, marked rand weakness and higher inflation (adverse weather), significant load shedding and weak investment growth.
• Substantial fiscal consolidation ultimately occurs, preventing ratings falling into the C grades.

The characteristics of the lite down include failure to stabilise debt projections and a resultant fall into single B credit ratings from all three agencies for both local and foreign currency debt. SA has not received any upgrades yet, or positive outlooks.

The credit rating agencies still highlight risks, which could see downgrades for SA, including weak growth and the need for additional SOE financial support.

Nevertheless, the longer SA maintains its lowered debt and deficit projections (or lowers them further), the further the lite down case’s probability could drop, strengthening support for the rand. But this also depends on commodity prices and factors affecting EMs.

Rand one of the most resilient emerging market currencies

The rand has shown reduced volatility this year in comparison to other emerging market currencies, and this is also likely reflective of its somewhat reduced credit risk as markets perceive a lower risk of default.

The recent temporary respite in fuel prices, as the state cuts the general fuel levy from Wednesday in the face of an incoming price hike of around R1.80/litre otherwise, also shows some improved flexibility and governance of the state, which is market cheering.

The heavy handed approach in 2020 of the command council’s response to Covid-19 unnecessarily damaged the economy, causing the loss of around 2 million jobs. While 2021’s 11% revision to GDP rapidly aided economic recovery, it did not solve the job loss.

A policy response more in tune with the economy, financial markets and investor confidence, as Minister Enoch Godongwana is displaying, is benefiting SA and the rand, allowing for differentiation in SA’s favour between EM currencies, which is appreciated by the rating agencies. 

South Africa saw the official stats for Q1.22 record R4.9bn in foreign purchases of SA bonds (net of sales), with this capital inflow a strong beneficiary for the rand, and this final settled transactions data from the JSE reflecting general appetite through the quarter. 

Rand somewhat buffered from impact of US interest rate woes

The US saw its core PCE come out lower than expected, at 5.4% y/y instead of at 5.5% y/y, the FOMC’s preferred measure of household expenditure price inflation, and this will have benefited market sentiment slightly. US CPI and PPI are due around mid-month.

Concerns are circulating on the severity of US interest rate expectations and the attendant increasing risk for a US recession, while the Russian/Ukraine conflict persists. However, in SA the improving credit metrics have come at a good time to add a buffer for the rand. 

Moody's adds that it “expects that the government will continue to pursue its fiscal consolidation strategy. In the meantime, tax compliance is likely to improve gradually as the South African Revenue Agency (SARS) rebuilds some of its intuitional capacity”.  

SA’s expected case probability of no downgrades has increased, and  reflects a more certain environment for SA’s state finances, although reforms to the onerous regulatory burden and polices impeding free market dynamics which are urgently needed to bolster growth. 

The appreciation of the rand over the past few days is a reflection on the FOMC's bullish reading on the US economy. Indeed, the currency may have fared even better were it not for expectations that the war in Eastern Europe is likely to be a protracted one. 

Currencies have differentiated on the basis of the expected growth impacts from the Russian/Ukraine war, with the Euro -2.93% weaker since the start of the year, and the Swedish krona, British pound, Danish krone down -4.1%, -2.60% and -2.96% in the period.

In contrast, commodity exporters have seen currency gains, with the Norwegian krone and Australian, New Zealand and Canadian dollars stronger by 0.86%, 1.12%, 1.28% and 2.71% respectively since the start of this year. 

The rand, by comparison, is 6.13% stronger since the start of this year, benefiting also from the higher interest rate expectations for 2022, with South Africa’s Forward Rate Agreement (FRA) curve continuing to price in a 2.00% increase by the end of 2022.

South Africa’s bond yields are around 50bp higher than before the start of the war in Eastern Europe, which has benefited portfolio inflows. Foreigners bought R2.9bn worth of SA bonds in the last two days, net of sales, pushing the rand towards R14.80/USD. Iress JSE data also recorded net purchases of -R19.6bn for equities since the war began. 

The rand is currently averaging R15.29/USD this quarter, frquently dropping below R14.90/USD in the last few days, driven by improved market sentiment to SA as risk aversion remains differentiated across emerging market currencies. 

Talks between Russia and the Ukraine have so far failed to reach a permanent ceasefire and countries with geographical proximity to the conflict are likely to see their currencies negatively impacted for as long as the outcome hangs in the balance.

Since the start of the Russia/Ukraine war, the rand has strengthened against majopr currencies. The currency is currently trading at R16.38/EUR and R19.60/GBP, compared to R17.12/EUR and R20.52/GBP prior to the breakout of hostilities. It has also held firm aagainst the US dollar.

Not only have commodity exports benefited from elevated commodity prices, but SA bond yields have also risen by about 50bp since the conflict broke out.

Markets continue to price in substantial interest rate hike expectations. Concerns about local and global inflation have only intensified as supply cuts from Russia and the Ukraine drive a rapid acceleration in commodity prices. Heavy commodity exporters like those in SA, who are geographically removed from the war, are finding favour. But markets are now increasingly worried by the prospect of stagflation (high inflation, lower growth). 

Foreigners have bought R15.5bn worth of SA bonds, net of sales, since the 24th February (Iress JSE data), with the same data source showing net foreign sales of SA bonds of  -R44.7bn, although bond settlement data from the JSE reduces this to -R10.5bn (Bloomberg).  

The -R10.5bn outflow is settled bond data, and so is regarded by the JSE as an indication of capital flows, whereas the daily data on bond trading refers to reported transactions (viewed as a liquidity indicator), but includes unsettled trades as well as rollovers, inflating the data.    

For metals and minerals prices, the March reading is so far up 40% y/y (Economist commodity price index), on an already elevated period, driven substantially higher by aluminum, coal, iron ore and particularly nickel, while precious metals are also benefitting.

So too, maize prices are substantially up on the year, by 26% y/y, a key export for SA, while SA sees substantial sunflower seed imports from  Botswana, and soybean imports from Zambia, with about half this amount again from Malawi and Zimbabwe (SAGIS data).

The rand is averaging close to R15.35/USD this quarter, attempting the R15.00/USD key resistance level a few times in the past two and a half weeks, driven by improved market sentiment to SA as risk aversion has differentiated across emerging markets.

As South Africa heads towards the middle of March, and then on to completing Q1.22, the rand so far averages R15.35/USD, supported by commodity prices as markets have viewed the Russian/Ukraine conflict as more of a supply disruption than a severe threat to global growth. 

Currently the rand is at R15.37/USD, and we still expect R15.40/USD as the quarter average, although the domestic currency is at risk of weakness in the remainder of this month – for as long as the Russian invasion of the Ukraine continues, and worsens.

Markets are now worrying that the Russian/Ukraine war will persist substantially longer than the quick conflict originally anticipated, and a lengthy  invasion will have more severe effects on the global supply chain and so commodity prices, but WWIII is not yet expected. 

Sanctions are deepening, with global discussions now on banning/limiting imports of Russian fuels, and the Brent crude oil price spiking to US$128.7/bbl and at risk of reaching US150/bbl. Strategic oil reserves have been released into the markets already to attempt to quell the price pressure.  

The Western response has been substantial, coordinated and committed, while Russia has been unwavering in its objectives for the Ukraine. Hope persists for a resolution, but it is not likely going to be easy, or necessarily quick and markets are beginning to reflect this.  

Financial markets have seen also some jitters as the US currently continues with its plans to hike interest rates (with a 25bp hike next week), but the rand remains among the top five EM currencies in terms of performance, both from the start of the year and on a year ago.   

However, US treasuries’ yields have subsided, with the benchmark ten year now at 1.72% from 1.88%, as markets now worry over a worsening of the war in Eastern Europe, and so financial market instability, leading to less likelihood of a marked interest rate hike cycle.

Should the tensions with Russia and Western countries escalate further and cause marked financial market instability, the US may delay its interest rate hike next week. It would likely add in supportive measures if markets near a crisis (not the expected case). 

A high proportion of SA’s fuel prices are government levies, and temporarily removing these would reduce a sudden extreme fuel price jump, while state support to combat the effects of food spikes such as bread prices on rapid wheat price escalations would also be necessary.

After a recent weak point on Thursday last week of R15.53/USD when the Russian/Ukraine war began, the rand has pulled back slightly. Despite substantial financial, humanitarian and military equipment aid to the Ukraine, the conflict has not widened to include any other countries. 

Severe and broad-based sanctions imposed by most Western countries on Russia have seen the rouble weaken by -24.4% to date since the start of the year, while the Ukrainian Hryvnia is -7.3% weaker over the same period. 

This morning, the rand was just -1.9% weaker since the start of January. This was an improvment on yesterday’s -2.45% depreciation in the comparable period, as risk aversion eased somewhat, with talks on a possible ceasefire underway between Russia and the Ukraine.  

The rand even broke through R15.30/USD level, reaching at R15.25/USD, as markets hoped for resolution on the conflict. But Ukraine was not optimistic on a ceasefire and Russian forces were reported to have continued their attacks during the talks. 

The EU, Britain and other Western allies have instituted broad sanctions and export controls of military equipment to Russia so far. These include sanctions against Russian companies, business leaders, government officials and banks. 

China has not indicated that it will increase imports of Russian goods to fully counteract the impact from sanctions, and instead is particularly concerned about its reported US$1.6trillion in trade with the EU and US. China’s trade with Russia is estimated only at US$0.1trillion.

China buys mainly oil and gas from Russia, and has been keen to buy more. It is also reported to be increasing wheat imports from Russia. The oil price reached US$103/bbl today and is likely to climb further on an intensification of conflict, bolstering inflationary concerns.

Around midday today it was reported that Russia is set to intensify its attack. A long convoy of vehicles is en route to encircle Kyiv, while missiles have struck Kharkiv (Ukraine’s second-largest city). 

There is no end in sight for the Russian/Ukraine war will end, and it's uncertain how much more it will intensify. Russia is unlikely to back down easily: a much harsher second wave of attack looks more probable. As a result, the rand is at risk of further weakness this month.

As tensions escalate in the Ukraine, with Putin unlikely to back down easily or permanently, the rand is holding onto recent gains.  

An actual third world war is not anticipated, despite key nations entering the fray with targeted economic sanctions, if not large-scale troop deployments.

In South Africa, the Budget this week is not expected to offer much in the way of lowered fiscal projections, let alone fiscal consolidation back to pre-pandemic levels in the near term. And it's worth noting that fiscal health was a serious concern for the economy even before the pandemic.

South African rand bonds continue to attract investors with high yields. Should Minister Godongwana rebuff sceptics and announce a further lowering in debt and deficit projections, this would add to positive sentiment towards South Africa's debt and the ZAR.

In any event, no credit rating upgrades are expected as a result of the budget. The best we can hope for is that Moody’s considers removing its negative outlook should the budget be positive. The rating agency is set to meet on 1st April and 18th November this year to potentially deliver a credit rating action. S&P’s dates are 20th May and 18th November for this year. Fitch does not publish dates for South Africa’s credit action, but tends to show a similar pattern.

The credit primary objective of the credit ratings agencies in assessing a sovereign/entity’s credit worthiness is to assess the likelihood of repayment of debt. As such, we can only expect to see credit rating upgrades from any of the key ratings agencies once SA is able credibly to lower its projected debt trajectory to peak around the current ratio. Thid would be positive both for the rand and SA’s bonds.

However, the country's current economic fundamentals, weakened by the sluggish pace of structural reform, electricity supply constraints and high unemployment, are not consistent with such dramatic improvements in the debt trajectory.

January saw the rand run back down from above R16.00/USD, to close to R15.00/USD, and February continued to attempt to pierce this key resistance level, successfully achieving this today at R14.91/USD, on the resumption of the commodity boom, after H2.21’s slowdown in commodity prices.

One of SA’s key exports, metal commodities’ prices, are tracking back towards the prices of Q2.21, and others such as agricultural food, and nonfood, commodity prices (all measured by Economist commodity indices) are at nine and ten year highs respectively.

Industrial commodities’ prices are also at ten-year highs currently, as the three categories exceeded their previous high price points in the current commodity cycle.

SA has been shielded from high oil prices as a consequence of its strong exports of other commodities, but would see further rand strength if it uses its own oil instead of heavily importing it.

South Africa’s terms of trade are reflective of bolstered commodity prices, and so export values, with February likely to record another good trade surplus, and quite possibly a budget surplus too, repeating December and June’s twin surpluses achievement.

Marked commodity price strength is occurring, despite the rapid quickening in US QE tapering and likely hike in the fed funds target rate in March, and indeed may well be aided by it, as markets see this as strong confidence from the FOMC on future US economic, and so global, growth and demand.

In turn, this would provide further demand for commodities, which are already seeing severe supply shortages on demand, rapidly drive up prices, in turn a positive environment for commodity currencies and exporters. International factors continue to drive the rand in the main.

The rand will remain volatile, at high risk of further substantial moves, but is also weakened by SA’s inflation rates remaining well above those of its key trading partners, the EU, US, UK and China on a long-term basis, despite short-term dislocation of this relationship in some areas. 

South Africa continues to see investor appetite, particularly on the domestic side for government debt,  while the rand is performing well compared to other emerging market currencies, all against the US dollar.

Currently the domestic currency is 4.5% stronger since the start of the year. On a year on year (y/y) basis it is -3.6% weaker, but sits in the midst of the emerging market basket of currencies, all generally weakened by the US monetary policy normalisation process.

A year ago the rand was around R14.40/USD, but then weakened through March as the domestic currency experienced some usual seasonal patterns of weakness into the second quarter, although in the second quarter itself the domestic currency bucked this trend.  

By June the rand had reached R13.40/USD, driven by the combined favourable global market sentiment and SA's strong trade performance, as SA’s markedly positive terms of trade (or the ratio of exports to imports) was lifted by strong commodity export prices.

The rand also benefitted from strong global growth expectations, which underpinned market sentiment, and so an investor risk-on environment, as global monetary and fiscal policies remained highly supportive for economic growth.

However, the third wave of Covid-19 infections, and political tensions as key figures attempted to escape prosecution for corruption, pushed the rand back above R14.00/USD by end June last year, as investor appetite into EM portfolio investments differentiated.

The rand then weakened on the radical destruction of economic activity and infrastructure in a number of areas in SA in July’s riots, reaching R15.00/USD briefly in July, and then was subsequently afflicted by market concerns over possible FOMC hawkishness.  

That is, the remainder of 2021 and early 2022 saw the rand impacted by concerns over US QE tapering and interest rate hikes, with the global macro-economic environment for 2022 set to be the least supported by policy measures since the pandemic began.  

The rand weakened beyond R16.00/USD by end 2021, pulling back in January on traditional increased risk appetite, but also on increased certainty on US monetary policy. The domestic currency is likely to remain volatile, unlikely to see substantial strength this year.

That does not mean commodity prices will collapse this year, far from it under the expected case. Instead, the rand has gained support from commodity prices, which should persist over H1.22, and into H2.22 although some moderation at times may occur as volatility persist.

This has counterbalanced quite a bit of the negative drag from the rapid US monetary policy normalisation process under way, with the rand continuing to attempt to near the R15.00/USD mark but not very assertively, while the Budget next week is not expected to upset it. 

IRESS data shows foreigners bought R4.7bn worth of SA’s portfolio assets this year (bonds R2.0bn, equities R2.7bn) all net of sales, and this positive sentiment is also buoying the rand, with rand bond yields still offering high breakeven (inflation adjusted)  rates.

Currently, SA’s 10-year breakeven inflation rate (market measure of expected inflation) is at 5.95%, still well above the US’s market measure of expected average inflation of 2.47% which jumped up from 2.4% earlier in the month as January’s US inflation print of 7.5% y/y shocked.

With the breakeven rates for both SA and the US in excess respectively of SA’s 3-6% target range with a midpoint of 4.5%, and the US implicit inflation target of 2%, markets are still stressed about future inflation outcomes, and in SA show less anchoring to the inflation target.

SA’s breakeven inflation rate in early February 2021 was 4.8% in comparison. While the current high breakeven rate appears out of line, SA’s high inflation rate at 5.9% is causing some concern, and translating immediately through into  markets.

The JSE data on settled non-resident trades in South African bonds reported by Bloomberg, with data for cumulated periods adjusted for backdated spot trades (but includes cancelled trades), gives different results to the IRESS reported data from the JSE for daily trades.

Nevertheless, the Bloomberg data also shows net foreign inflows into South Africa’s bond market since the start of year, as foreigners increased bond holdings on a net basis (purchases net of sales), attracted by SA’s high yields, while fiscal metrics improve.   

South Africa’s high yields are somewhat out of kilter with its improving, and projected improvements in its fiscal metrics since last year, with the yield on the ten year government bond still elevated above 9.00%, attractive to investors, but also with risks involved.

The rand so far this quarter averages R15.46/USD as it approaches the mid-point, supported by strengthening terms of trade over Q4.21 and into 2022 as commodity prices strengthened, also boosting the main budget surplus, with SA recording twin surpluses in December.

Both the trade and budget balances however are subject to some seasonality too, depending on the festive period and vacation days for the trade account, and timing for tax payments. Commodity price strength has also boosted corporate tax revenues and exports recently.

South Africa is a key commodity exporter, particularly of metals such as iron and other ores, platinum, gold and also of ferro alloys and coal and agricultural prices have also seen substantial increases, and so SA’s exports have been boosted by these price rises.

Global economic data continues to show improving demand, albeit at a slower pace than last year’s heady acceleration, as the world’s economic recovery is seen to remain on track to reach its levels achieved before the pandemic already by this year. 

South Africa continued to see trade surpluses last year far exceeding those of 2020, with the trade balance for the year as a whole at R441bn in 2021, versus R272bn in 2020,  and South Africa’s terms of trade positive through the whole of 2021.

SA’s trade surplus improved from June 2020 when the harsh lockdown restrictions earlier in the quarter eased, with exports increasing in the main, stabilising the rand around R17.00/USD from May to over Q3.20, and then around the R16.00/USD over Q4.20.

By the end of 2020, the rand had reached R14.69/USD, with the trade balance recording some very hefty surpluses, of R30bn to R40bn a month over H2.20, as commodity prices staged a strong recovery from Q2.20’s lows, and the trade war.

2021 saw trade surpluses average close to R40bn a month, versus close to R20bn in 2020 (and R5bn since 2010). By Q1.21 the rand averaged R15.00/USD and Q2.21 closer to R14.00/USD, although H2.21’s rand weakened and so did SA’s terms of trade.  

The recent gain in commodity prices has provided some support for the domestic currency but global PMIs have softened in SA’s key trading partners’ while supply chain disruptions and shortages persist, with the rand expected to be limited for substantial strength in H1.22.

South Africa’s budget surplus for December was also around R40bn, at R41.9bn. State revenues swelled to R212bn, with R93.7bn from corporate tax,  R47.8bn from personal income tax and R46.8bn from taxes on goods and services (including VAT’s R32.9bn).

The largest revenue category, corporate tax is up 74% year to date for the 2021/22 fiscal year (over the low base of 2020/21 (April to December) established by the very harsh lockdown restrictions, but still up, by 55.6% on the same period for 2019/20. 

For the fiscal year to date personal income tax collections are 14.9% higher on the same period in 2020/21 but only up 4.5% versus the same period of 2019/20, as the recovery is still modest for consumers in SA with many households not having recovered financially.

That is, the Transunion Consumer Pulse survey showed 55% of consumers’ incomes in Q4.21 were still negatively impacted by COVID-19 (versus Q1.21 62%). With inflation up 8.1% over the period this is unsurprising. 

The fiscal deficit at R219.1bn for the first three quarters of 2021/22 (SA has only seen two months in fiscal surplus so far for 2021/22), with the main budget deficit estimated at -R410bn this year, the actual outcome is likely to be less, closer to -5.0% of GDP than -6.6%.

The Budget on 23rd February is however not expected to result in any upgrades in SA’s credit ratings, coming in neutral overall as revenue overruns are eaten up by higher expenditure, particularly further social support, and so is likely to be fairly rand neutral.

The SONA due this week Thursday 7pm is expected to show little difference in content to prior years, and there have been little new implementation of reforms sufficient to likely drive economic growth beyond 2.0% y/y this year, particularly on reducing the regulatory burden.

Moody’s this month warned that it is likely that South Africa’s “(m)acro-economic conditions will remain difficult, with sluggish economic growth, rising government debt and limited progress on economic reforms due to social and political obstacles.”

Adding that it “expects real GDP growth of just 1.8% in 2022 as political tensions and reform inertia have brought about exceptionally low business confidence. Labour-intensive sectors will continue to be hit hardest, with employment levels remaining weak.”

The rand has weakened to R15.76/USD today. It is highly volatile on the deterioration in market sentiment as excessive interest rate hike cycles are being priced in, causing concerns about economic growth outlooks, and raising risk aversion levels.  

The rand today mostly traded around R15.50/USD, at the expected average level for Q1.22 overall, but we expect to see ongoing volatility this quarter. Market expectations about interest rates are likely to eventually become more rational, but sensitivities remain elevated.

Foreigners are now sellers of SA markets year-to-date, dumping -R3.6 billion of SA equities (net of purchases), and -R5.5 billion worth of SA bonds (also on a net basis) in the last week alone. Foreign outflows from South African portfolio assets this year so far total -R3.0 billion.

Investors have been re-positioning for a higher global interest rate/lower economic growth environment. The fed funds futures (which indicate how the market expects Federal Reserve policy to change) currently price in a 1.25% overall hike in the fed funds target rate this year. This equates to a 25bp hike at virtually each monetary policy meeting (five out of seven).   

Such a severe rate hike trajectory is seen as likely to be destructive for economic growth. Meanwhile, inflationary pressures in the US are expected to ease from Q2.22, meaning that markets could see further volatility as investors adjust their expectations once again. 

The rand continues to be influenced by global markets, ignoring good news on the domestic front. For example, revenues are 34.4% higher year-on-year (y/y) for the first three quarters of the year 2021/2022 compared to the same period of 2020/2021. That said, the increase comes off a very low base given 2020/2021 was the period most affected by lockdown.

These main budget revenue figures show that 76.8% of planned revenue of R1.5 trillion has been collected so far, while only 71.8% of allocated expenditure has occurred. A significantly smaller deficit, of closer to 5.0% of GDP (versus -6.6%), is likely if this trend continues.

A quicker moderation in the fiscal deficit than the forecast provided in the November 2021 Medium Term Budget Policy Statement (MTBPS) would be positive for the rand. The higher revenue figures tie in with the improved transactions seen over December from BankservAfrica (see last Covid-19 note, email address below).

Data continues to show strengthening evidence that the SA economy is recovering from the effects of the pandemic, albeit not in full yet. Markets are worried about the impact of substantially higher global and domestic interest rates.

The rand has reached R15.09/USD so far today, as it now targets the key resistance level of R15.00/USD, having convincingly broken through R15.20/USD, benefiting from risk-on sentiment in global financial markets, and from related commodity price strength.  

Foreigners have been positive on SA markets so far this year, purchasing R5.8bn worth of SA bonds (net of sales), and R2.2bn in equities (also on a net basis) in the middle of last week. Overall foreign inflows into South African portfolio assets this year so far total R5.5bn.

This continues to support the rand’s strength, along with strengthening commodity prices, with the (Economist) index for metals prices up 4.6% m/m in January after December’s 9.6% y/y rise, as markets continue to anticipate robust global recovery.

The rand is likely benefiting from a trade surplus in January, as seasonally weak imports at the start of the year, and strengthening metals commodity prices from November, see the domestic currency gain against other currencies generally.

Overall commodity prices are up by 7.8% y/y, and food and non-food agricultural goods are 1.8% y/y and 28.9% y/y higher (also Economist commodity price indices), with SA also seeing substantial exports of agricultural food and nonfood goods. 

Adding to positive market sentiment, Fitch has said that the credit rating outlook for emerging market economies (Ems) is improving, albeit with risks. “The emerging-market (EM) sovereign rating cycle has turned more positive with four upgrades... continuing economic revival after the pandemic, nascent fiscal recoveries and higher commodity prices add up to a moderately net improving or neutral macro credit environment for the main EM regions in 2022”.

The recent approval of a US$750million World Bank developmental policy loan (DPL) for SA to aid in relief for those negatively affected by the Covid-19 pandemic is seen as market positive. The loan does, however, come with currency risk despite the low funding cost. 

Low levels of risk aversion on global financial markets tend to drive the domestic currency higher at the start of the year, and the rand could quite likely see further strength in Q1.22.

The rand has reached R15.29/USD today, as it continues to attempt to gain the key resistance level of R15.20/USD, but is being firmly rebuffed from this major level. The domestic currency so far averages R15.67/USD for the first few weeks of this quarter.  

Foreigners are positive overall on SA markets this year to date, purchasing R4.4bn of SA bonds (net of sales), and R1.2bn in equities (also on a net basis) in the middle of last week. Overall foreign inflows into South African portfolio assets this year so far total R3.0bn.

This has supported the rand’s strength, along with easing monetary policy in the world’s largest emerging market economy. China’s first cut in its key interest (one year loan) rate since April 2020, of 10bp, occurred as its economic growth slowed, lifting sentiment for EMs.

While the global monetary policy trend is for reducing accommodation, by tapering QE and hiking interest rates, China’s move has positively impacted global financial market sentiment further and is aimed at supporting economic growth in the world’s second largest economy. 

China’s modest inflation, and concerns over its economic growth outlook on its property market’s weakness, and the negative impact of Omicron on its economic activity, has seen the emerging market cut interest rates, with further moves expected. 

In contrast, the US is on a firm path to withdraw its easy monetary policy as its very high inflation environment worries policy makers, while its economy and labour markets have shown good recovery and are expected to make further gains.  

Indeed, US CPI inflation may not have peaked at its current forty year high of 7.0% y/y, with Q1.22 at risk of a further lift. In contrast, China’s CPI inflation came out at 1.5% y/y in December, below November’s 2.3% y/y and the market’s expected 1.7% y/y.  

Omicron has spread rapidly through China, with it maintaining a zero covid strategy which is feared to likely quell consumption growth contributions to Q1.22. Broader monetary easing is likely on rate cuts and a lowering in its reserve requirement ratio for banks.  

However, China’s structural changes to its economy have seen more serious growth concerns than can be addressed with monetary easing, and provides some risk to the global growth outlook, along with overly harsh US rate hikes, with the rand likely to remain volatile this year.  

Driven by a myriad of factors, the rand strengthened to R15.57/USD on Monday in its usual bout of seasonal strength. The currency is expected to average R15.50/USD this quarter, although risks of volatility and weakness remain. 

Foreigners have been active in SA markets this year so far, purchasing R2.6bn worth of SA bonds (net of sales), and R0.7bn worth of equities (also on a net basis) in the middle of last week. Overall, foreigners sold only -R0.4bn worth of equities (net of purchases) this year.

Foreign inflows into South Africa’s portfolio assets this year so far stand at R2.2bn, which has bolstered the rand, and the favorable risk appetite is being driven by the usual increased seasonal risk taking of foreigners towards rand assets over the turn of the year. 

The northern hemisphere winter typically sees increased investor interest in SA markets as most market players are at work compared to the thin market months in the northern hemisphere summer vacations.

Heightened risk taking typically occurs over the northern hemisphere winter versus the low risk taking in the northern hemisphere summer. Rand assets are often in particular favour given the high liquidity and sophistication of the domestic financial markets. 

Consequently, the rand tends to strengthen in the first and last quarters of the year and weaken in the middle two quarters of the year and this seasonality particularly comes to the fore when other drivers of the domestic currency are more subdued.

The recent FOMC minutes and meeting of 15th December 2021 provided the markets with significantly more certainty on the US monetary policy normalisation process, and consequently has reduced risk aversion for markets. 

With expected US rate hikes this year (the Fed fund futures are currently expecting up to three 25bp increases) and QE ending signalled as early as March, markets are relishing the increased certainty of the outlook, bolstering foreign investor portfolio flows into SA. 

The rand consequently could strengthen through the R15.50/USD mark this month, potentially as early as this week, and moving towards R15.00/USD this quarter, if not stronger, although the domestic currency will also remain highly volatile. 

After briefly reaching R13.40/USD, R16.32/EUR and R18.96/GBP this year in early June, the rand weakened to R16.37/USD, R19.02/EUR and R21.77/GBP by December, as markets factored in higher US interest rates from next year.

Markets currently expect the Fed funds target rate will be hiked three times, by 25bp in each move, by early 2023. South Africa’s FRA (Forward Rate Agreement) curve has elevated sharply, anticipating that the repo rate will be about 2.00% higher by then, which is likely overdone.

However, interest rate expectations have been rising in SA as the SARB’s tone has proved particularly hawkish over the past few months, resulting in an early 25bp hike in the repo rate in November this year, with markets anticipating another lift in Q1.22 - which will likely occur.

The start of the normalisation of US monetary policy with QE tapering early in November would have been a key factor in spurring SA’s repo hike. US inflation is high, and markets expect a further rise on Friday in the CPI, to 6.8% y/y from October’s 6.2% y/y, which would lend support to pressure in the FOMC preferred measure of Inflation, the core PCE deflator.

The recent US jobs figures, while disappointing in the headline payrolls data, show on deeper analysis strengthening in some areas of the jobs market, and so lower unemployment. The Fed is likely on track for quickening the pace of QE tapering, which would provide an underpin for rand weakness into H1.22.

The US is unlikely to see a reduction in its pace of QE next year, despite the fourth wave of Covid-19 globally, and in the US, and indeed potential further waves of Covid-19, driven by new variants.

The US is powering ahead with further fiscal stimulus as it plans to continue to normalise monetary policy over 2022, and this will put pressure on SA to hike its interest rates further as the timing for US interest rate hikes approaches.

Foreign investor flows into emerging market assets have cooled, with most of the riskier jurisdictions losing out, particularly on fears of the fourth wave of Covid-19 infections, although risk sentiment has begun reversing this week as markets begin to digest the more modest impact of the Omicron variant on those infected than was feared.

The rand is likely to remain volatile, weakening over the long-term as SA’s inflation rates remain well above those of its key trading partners, the EU, US, UK and China, despite short-term dislocation of this relationship in some areas, although not to the rand’s benefit. 

The rand has strengthened to R15.93/USD so far today, but pierced below R16.00/USD on Friday as the domestic currency remains choppy, pulled in different directions by the very low US nonfarm payrolls numbers but with many still expecting a quickening in US QE tapering.  

Versus the expected 550 thousand expansion in jobs, only 210 thousand new jobs were recorded on the November payroll system, as uncertainty around the impact on the economy of a quicker taper, and so sooner rate hikes, in the US afflicted the hiring figures.

The weakness represented by these jobs figures was broad-based across a number of sectors, with non-farm payrolls just under half a million jobs below the level before the pandemic. However, individuals continued to gain work, just not as quickly as anticipated. 

Household employment, versus company and government above, saw 1.1million jobs gained and unemployment dropped to 4.2%, from 4.6%. Although household employment is volatile, and may slump early next year, markets were cheered by the lower unemployment rate. 

However, there are still 2.4million individuals less in employment overall versus before the pandemic, despite the US labour force increasing by 549 000 individuals in November, going some way to easing labour shortages, but with a still relatively tight market. 

The labour force participation rate is up, as are hourly earnings, the later higher by 0.3% , and this measure of wage inflation is up 4.8% y/y, signifying some upwards pressure from this source for November’s US CPI, with US CPI inflation at 6.2% y/y in October.

The divided data does signify a recovering jobs market (and aggregate labour income is reported 10.4% higher y/y), with the FOMC meeting on 15th December to decide on whether to quicken its tapering of its asset purchase programme.

The FOMC may well taper further, as both household savings and expenditure are fairly robust, and PCE is expected to remain healthy well into the first half of next year. Markets are still digesting the jobs data leading to further volatility for the ‘more risky’ risk assets. 

The rand remains vulnerable, as while this time of year typically sees more market calm, the progress the US is making in the normalisation of its monetary policy is heavily disrupting it, although it would have likely been worse in the typically risk-off period for the rand of Q2/Q3.

The rand strengthened to R16.07/USD today, from R16.37/USD on Friday as news of the Omicron variant broke widely and travel bans were instituted against SA from many advanced economies on concern over the potential high contagion of the new variant Omicron.   

However, Dr. Coetzee, chair of South African Medical Association and a member of the Ministerial Advisory Committee on Vaccine, noted very mild symptoms so far with the new variant, "which did not fit in the clinical picture" of the delta variant. 

"The most predominant clinical complaint is severe fatigue for one or two days. With them, the headache and the body aches and pain." The Omicron variant is currently seen as potentially much milder than the delta variant, with patients able to be treated at home.

Omicron, first identified in Southern Africa, was declared a "variant of concern" on Friday by the World Health Organisation (WHO) and financial markets reacted negatively to the news. But today the knee-jerk reaction seemed to have subsided somewhat. 

In last night’s address to the nation, President Ramaphosa confirmed that “if cases continue to climb, we can expect to enter a fourth wave of infections within the next few weeks, if not sooner.” Overall, he took a sensible approach, without any increase in lockdown levels.

The rand gained some cheer from the speech, with the President emphasising that we already have the tools that we need to protect ourselves against the new Omicron variant of Covid-19: mask-wearing, social distancing and vaccination.       

“We are still not sure exactly how it will behave going forward," he added. “We know enough about the variant to know what we need to do to reduce transmission and to protect ourselves against severe disease and death.” 

It's worth noting that the rand was already at close to R15.90/USD before the news of Omnicron's discovery broke widely, and the currency had breached R15.00/USD ahead of the FOMC meeting in early November on QE tapering expectations.

The rand is likely to remain highly volatile. Non-farm payrolls data out on Friday and a strong number will boost market expectations of quicker QE tapering, although the global increase in Covid-19 infections, particularly in the US, will be of FOMC concern.

Risk classes continue to be heavily graduated, with  EM assets losing out, particularly in the currency space while advanced economies continue to see gains particularly in equities, and this has benefited SA equity prices too, but the rand remains mired weaker.   

Figures from Iress and the IFF (Institute of International Financial) show that -R29bn in bonds owned by foreigners were sold in November net of purchases, after a -R32bn on a net basis in October, and a loss of -R30bn in September. 

Foreigners have also been dumping SA equities on a net basis according to the same figures, with -R9bn sold off in November, -R20bn in October and -R6bn in September (August -R11bn), and indeed each month recording a net sell-off this year.

The Fed QE tapering has added to negative foreigner investor perceptions of emerging markets. The MTBPS recently warranted no change in SA credit ratings from Moody’s and S&P, with no comment from Fitch either. 

Moody's “completed the periodic review of a group of issuers that includes South Africa and may include related ratings through a discussion held on 14 October 2021. The review did not involve a rating committee, and this publication does not announce a credit rating action".

“The (existing) credit profile of South Africa (issuer rating Ba2) reflects the country's "baa3" economic strength, balancing deep-rooted structural impediments to growth against its deteriorating but still strong economic resiliency derived from economic diversification”.      

Furthermore, “its "baa3" institutions and governance strength based on the country's robust ranking in the Worldwide Governance Indicators and evidence of the institutions' capacity to preserve macroeconomic stability”.  

While “its "caa2" fiscal strength reflects the continued, long-standing rise in government debt levels and deteriorating debt affordability, and its "baa" susceptibility to event risk driven by political risk and banking sector risk.”

The rand currently averages R15.00/USD so far this quarter, with just over half the quarter reached. The ongoing negative market sentiment to EM’s risks further vulnerability for the domestic currency. Both Moody’s and Fitch have retained SA on negative rating outlooks.

The recent lift to R14.93/USD after a low of nearly R15.50 last week comes as recent improved US jobs numbers indicate further recovery in the US after the impact of the delta wave.

Seasonally, the last quarter of the year, and first quarter of the next, are often strong for risk assets, and the robust upward momentum in global equities is also improving risk-appetite further, with the rand potentially making additional gains this week.

However, both the medium-term budget policy statement (MTBPS) and some further signalling on political coalitions this week may have room to upset the domestic currency. In particuar, the market will be watching with concern as the ruling party mulls coalitions with the EFF in municipalities where it has not achieved a majority.

While Thursday's MTBPS is expected to bode well for further fiscal improvement, additional heavy expenditure commitments over the medium-term could counteract this, while increases in the projected rand value of borrowings would be market negative. Tax change announcements are unlikely, but the new finance minister is expected to provide clarity on inflation targeting policy, exchange controls and potential future taxation directions. 

SARS has been making strong progress in a number of areas and the MTBPS should give detail on this and some upwards projected revenue adjustments - SA’s revenue GDP ratios otherwise risk dropping on the recent surveyed enlargement of the economy by Stats SA. 

SA’s debt and budget deficit ratios, which we expect at 69.8% for gross loan debt and a deficit of -7.5%, both as a % of GDP, could both surprise on the lower side for this year, with potentially the budget deficit closer to 6.5%. 

National Treasury will likely announce some plans of a form of more permanent financial assistance for the unemployed as the social relief grant wears out, with the potential permanent social transfer likely to be tied to job seeking as opposed to an outright grant.

The domestic currency could be in for a strengthening run this week and next if the budget figures surprise on the positive side leading into the country reviews on 19th November, where we expect no change, although much will depend on the ANC coalition partner/s.

The domestic currency ran to R15.49/USD ahead of tomorrow’s US FOMC meeting outcome, with market participants fearing indications of a quickening in FOMC member’s interest rate hike forecasts, although the actual dot plot forecast graph is not due. 

The FOMC meeting tomorrow night is hoped to give a clear indication on whether there is a reduction in dovishness of the FOMC. A start to QE tapering would be an indication of a reduction, as would any marked worries on inflation, but would be negative for the rand. 

The US PCE deflator out last week at 4.4% is high, but in line with expectations, while the US GDP outcome disappointed down to 2% q/q annualised, versus previously 6.7% and expected at 2.6% for Q3.21. 

However, October is showing some good University of Michigan readings, while the ISM readings are up into the 70s also for October. Even the Markit PMI was above 50 for the US last month. However, inflation readings are high across the board. 

The mixed data for Q3.21 in the US, versus individual economic data reading in October for a number of areas of activity, appears to be indicating a lift in GDP in Q4.21, although only one month’s partial set of data may be too sparse for the FOMC.

Additionally, while the inflation readings have proved much stickier than initially thought, the FOMC has not panicked about them, with wage increases pushing up, showing second round effects, but these are also due to labour shortages. 

Markets are worrying over FOMC QE easing, and this is afflicting the rand today, and will likely continue to do so tomorrow until the meeting tomorrow night. South Africa’s municipal election results are starting to come through today. 

With 40% counted by 4pm today, the results reported so far show the ANC at 47% of the vote, the DA 23%, EFF 10%, IFP 4% and the remaining parties all below 4.0% each for the tally nationally, but with very mixed results in municipalities.  

Having reached R15.49/USD today, the rand has strengthened somewhat to R15.42/USD, and will likely remain volatile and weak ahead of the FOMC meeting, and with risks from the election outcome. So far the rand averages R14.81/USD for the month of October.

South Africa’s risk of credit rating downgrades remains relatively high (we continue to place it at 43%) as seen by ramp up in borrowings, while fractured politics pulling in different directions, exacerbating the difficulty government has in overcoming structural constraints. 

The ruling party has attempted to move quicker on structural reforms, but opposition to this from both inside and outside the party has seen little actually occur in moving the country into a freer market state needed to accelerate business dynamism, and so erode unemployment. 

While government has made some progress in improving the ease of doing business and has also made inroads into the repair and rebuilding of many SOE’s and government institutions hollowed out by state capture, the enormous damage makes it a lengthy, ongoing task. 

Consequently, Fitch is reported to have said it expects South Africa to see weak gains in tackling the very high unemployment rate, particularly for youth, given the many structural constraints to job creation, including the poor educational system.

Furthermore, “Fitch expects (South Africa’s) unemployment rate to average 29.9% over our long-term forecast period to 2030, due to problems in the education system and labour market rigidities”.

It expected a deterioration in SA’s fiscal situation, projecting ”gross government debt to reach 82.9% of GDP by 2026, increasing from 69.4% of GDP in 2020,” which it said would negatively affect the economy and lengthen the path to achieving investment-grade again.

Fitch adds that while it expects some progress, as government has allowed private power generators to provide more capacity, most of these additions would only begin in H2.22 which means the economy would continue to see power supply constraints in the interim.

Consequently, Fitch expects GDP growth of 2.5% y/y for SA next year, after its rebound of 5.0% y/y this year, with a slowdown in global economic growth likely next year which would detract from SA’s performance as well. 

The rand is facing headwinds this week, and currently averages R14.82/USD so far this month. However October often sees some churn for risk assets, with the rand having recorded a low of R14.35/USD and a high of R15.20/USD in the past three and almost a half weeks.

The rand has seen some strength last week on the potential reprieve to EM currencies from a later tapering in US monthly asset purchases, as markets continued to digest the weak outcome of US jobs market data with resultant US dollar weakness.   

Recent FOMC communication on a gradual tapering was also supportive, as was the underscoring of still distant US interest rate hikes in the release of its last meeting minutes, with more stringent requirements for hikes then for the start of tapering. 

Indeed, the rand strengthened to R14.60/USD early today, currently averaging R14.91/USD for the first two weeks of Q4.21, but has room for further strength, particularly this month and next, with the first and last quarters also typically seasonally strong for the rand.  

Markets will still keep a close eye on US economic data releases, and the rand is at risk of weakness in particular on signs of a marked strength in the US jobs market data, as expectations have begun to see some shift from a November to a December tapering.  

Additionally, the PBOC (China’s Central Bank or the Peoples Bank of China), is reported to have said that Evergrande’s (the Chinese property developer giant) risks to the financial system are “controllable”, and so not expected to spread, calming international markets.

So too, another risk driver at the end of September, the unresolved fiscal cliff at that point, has seen a reprieve to December, with markets shrugging off some risk concerns in the interim (QE tapering may well only occur in December).

The rand has found resistance at R14.60/USD, and likely this will remain a key resistance level for the currency, as markets temporarily make use of the unexpected (to a number)  bout of strength in the domestic currency for some sell-orders.  

The rand could see some further attempts at the R14.60/USD resistance level this month and in November, if risk aversion remains moderate, and indeed subdues further in what can be a quiet period, particularly if market views for a December taper firm over this month.  

US inflation will remain of concern, although FOMC members’ continue to highlight that “there would likely be sustained downward pressure on inflation in the years ahead”, and the domestic currency will remain volatile, but potentially have a strengthening bias this month.

The large market surprise on Friday’s US non-farm payrolls saw substantial US dollar reaction. Initial risk-off sentiment dissipated quickly and the rand is now beginning to strengthen as markets digest the nuances implicit in the news. The rand and other EM currencies could see further strength this week as market players continue to digest new US employment and what it means for its QE tapering.  

The market seems to have underestimated the impact of the US's third wave of Covid infections on the economy and jobs market. The paltry 194 000 jobs added was well below the market’s expectations of 500 000.

The latest report followed better than expected job numbers in September, with unemployment dropping to 4.8% from 5.1%, although this was impacted by some leaving the labour market.

But the jobs market picture is not as clear-cut as the numbers initially imply. The availability of labour remains a key issue. While the latest numbers might suggest a lacklustre employment market, demand for labour is actually strong. Coupled with a large drop in unemployed workers, the effect is upward pressure on wages. Markets will continue to digest the implications over the course of this week.

With unemployment benefits now set to expire in the US, the labour market is expected to show more convincing statistics of its overall recovery in Q4.21. 

Additionally, September’s jobs figures are seen to be impacted by seasonal factors, which will work out the system, seeing improvement later in the year. Until this happens, the Fed is unlikely to be in an inordinate rush to bring in tapering, and we expect that significant tapering could be delayed until December.  This could spell as reprive for EM currencies and the rand may see some strength this week.

The rand currently averages R14.58/USD, R17.43/EUR and R20.18/GBP this year. This compares to last year's averages of R16.46/USD, R18.77/EUR and R21.09/GBP. The currency is likely to remain much stronger this year than last, with market participants more willing to accept risk.

There are, however, a number of key factors US fiscal cliff has not helped to lessen risk-off sentiment in global financial markets, it is particularly worsened by the marked rise in US treasury yields, with the ten year reaching 1.54% at the end of last month, in anticipation of tapering.

The Institute of International Finance (which is the global association of the financial services industry) shows that South Africa saw substantial foreign sales of its debt over the past three months, totalling -US$3.6bn, or at an exchange rate of R15.00/USD by -R54bn.   

The IIF further shows that foreigners sold -US$4.6bn, or at an exchange rate of R15.00/USD -R68bn worth of South African equities in the past three months (July to September), adding to the drag on the rand, which weakened from R13.40/USD in June, to above R15.00/USD. 

Foreigners have also been substantial sellers of Mexican portfolio assets, at -US$5.4bn in the months of July and August alone, while Taiwan has seen a -US$3.2bn sell off for those two months, and Malaysia is close to -US$1.0bn, but China had a US$14.5bn net inflow.

As tapering is seen to approach, US treasury yields have elevated, and in particular markets have worried over a November taper, which has seen more movement in treasury yields recently, and has seen the rand weaken. 

.A December taper would only provide some brief respite to risk assets, with the rand often a key gauge of market sentiment. A full taper tantrum (severe negative impact on risk assets) is not expected when tapering begins, but tapering will place a drag on the domestic currency.

While the rand typically sees a stronger period in Q4 and Q1 each year, this will likely not be the case for Q4.21, although the domestic currency certainly is likely to be highly volatile and continue to see periods of marked strength and weakness indefinitely. 

That is, so long as the fundamentals of the currency do not deteriorate markedly (or conversely improve markedly), the rand will likely remain on a long-term depreciation trend, although cheeringly the chance of November credit rating downgrades has now reduced. 

Markets have continued to digest last week’s FOMC’s statement, which was initially perceived as balanced, with some dovish concerns, but worries have since been rising over the timing of forthcoming tapering, with US treasuries’ yield lifting.

Markets have also fretted over the elevation in FOMC member expectations for the target rate in 2023, with worries that this could show an increasingly hawkish bent, and so potentially tapering as early as the November meeting.

Markets are risk-off, also still concerned about reductions in democracy in China and Hong Kong, as China increases state authoritarianism, heightening regulatory restrictions on consumer and tech businesses and so worrying foreign financial investors into these areas.

The rand has reached R15.08/USD today, although subsequently pulled back to R15.02/USD, with the domestic currency on course to average around R14.60/USD for his quarter, although Q4.21 at risk. 

South Africa has also seen its election season kick off with the release of parties’ manifestos over this weekend and into this week (the ANC is still to release its guiding document), also adding to the risky environment the rand is currently facing. 

China has also brought through a clampdown on crypto currencies, causing these to weaken, and the regulatory tightening in the tech sector has been very severe in general this year,  negatively affecting corporate giants in the industry, and investors exposures to them.  

Credit stress is now seen as an increasing risk, with China cracking down on debt (in particular speculation funded with debt) and its overheating housing market adding to stresses, with the communist state also seeking to gain some control over house prices.

Indeed, Chinese property firm, the over leveraged Evergrande, is being seen as having the negative potential of Lehman brothers collapse, although expectations are growing that the Chinese government could bail it out.

Nevertheless, a slew of factors are creating rising risk aversion in financial markets, currently, and the rand is likely to remain volatile, with some dependence on the direction China may take on a potential Evergrande bailout to avoid its default on upcoming debt.

The US is facing two days of monetary policy discussions, culminating in potential guidance on future tapering of QE. While markets don’t necessarily expect QE tapering to begin in September, there is very high sensitivity to any indication of when it will start. 

Reaching R14.86/USD this morning, the domestic currency has pulled back to R14.73/USD, with the rise in risk aversion negatively affecting commodity prices as well, causing a double whammy for the rand.

September’s FOMC meeting will also deliver projection materials on the Fed’s updated inflation and economic growth forecast, and interest rate expectations, while markets will also seek any indication of a more hawkish tone.

In particular, the Fed’s dot plot (interest rate expectations) chart caused concern in June when it revealed expectations of a quickening trajectory, as FOMC members brought forward rate hike forecasts to two increases in 2023. No further change would support markets.

In June, markets reacted negatively to the quickening in FOMC members’ forecast rate hike trajectory, and the rand weakened from R13.68/USD to R14.10/USD, although Governor Powell warned against reading too much into the dot plot, at the time. 

The Fed Chair also highlighted in June the continuation of its asset purchases and interest rates near zero for the foreseeable future in order to “ensure monetary policy would deliver powerful support to the economy until the recovery was complete.”

In July, Jerome Powell reiterated this, adding that “the pace of the recovery in economic activity and employment has moderated in recent months, with weakness concentrated in the sectors most adversely affected by the pandemic.”

The US third wave continues to build, and has affected growth and employment. Deaths from Covid-19 continue to rise in the US, while those hospitalised in ICU are near the same high rates of the second wave. 

Global financial market sentiment, and the rand, would be further weakened from current levels if the Fed says this week that it would (as opposed to may) be appropriate to start reducing asset purchases this year.

The US has seen a small dip in its third wave, but it is too early to be certain this signifies an actual moderation in the wave itself. In the US and globally the path of Covid-19 remains uncertain, with further waves expected next year. 

The Fed has indicated a cautious approach to normalising monetary policy in the face of this uncertainty, which has benefited the rand and some other risk-on trades. But the pandemic's unpredictability has also caused some volatility, with market participants focusing on US economic indicators for clues on when QE tapering will begin.

US inflation remains historically high, due in large part to disruptions to both the US and global economies by Covid-19. High commodity prices and supply chain pressures are not likely to disappear in the short term.

Higher US interest rates would not help in forcing down supply side inflation pressures; nor indeed would reducing QE, particularly as the US economy is generally being recognised as having hit its growth peak this year in Q2.21.

The US third wave of Covid-19 infections has prevailed over Q3.21, and this will have dampened the quarter’s growth rate, along with consumer and business confidence. It's also continuing to weigh on the labour market, particularly as hospitalisations and deaths increase.

Recent lacklustre US labour market figures and supply-side inflation pressures have been largely ignored by hawkish proponents for sooner monetary policy normalisation, despite evidence of some demand side price pressures.  

It is concerning that scientists are not only expecting flare-ups of Covid-19 in many parts of the world next year, but also highlighting the risk of variants emerging that are significantly immune to current vaccines. 

Consequently, the path of the virus remains highly uncertain, which is reflected in the Fed's balanced approach -- providing monetary policy support to the economy in the short term while keeping a close watch on longer term trends.

The US continues to see a marked rise in its third wave of Covid-19 infections which is having a negative impact on consumer sentiment as well as market expectations for the rapidity of QE tapering, which previously was strongly anticipated for November even.

The Fed Chair’s comments on a dovish tapering process are increasingly being heard by the markets, after his Jackson Hole address, as key economic data readings continue to show a propensity to disappoint on the downside while the third wave builds.

Deaths too are surging across the US as the delta variant spreads rapidly, with just over half of the population vaccinated, and hard-line anti vaxxers persisting in still significant numbers, while Dr Fauci highlights a number of new variants of interest have emerged. 

New variants of interest include mu, which has been identified to have some similar characteristics as the delta variant, but the mu variant possibly may be able to surpass certain antibodies and so some vaccines. It has been found in around forty countries so far.

A variant of interest has the potential to do more harm than the strain it mutated from, with four others also of interest, eta, iota, kappa and lambda. The spread of delta through the US has already negatively impacted confidence measures, with worries over its growth outlook.

A tightening of lockdown restrictions is still not widely expected, in the face of strong anti-lockdown sentiment in the US. The Fed is likely to remain in no hurry to cause substantial QE reduction given the uncertainty, with its dovish approach having sparked some risk taking.

In particular, the Fed watches financial market sentiment, and if this starts to flag and turn significantly negative, it could also add to the FOMC’s caution in reducing QE. The third wave of deaths and cases has not yet peaked, and risks worsening substantially.       

The seven-day rolling average of new US Covid-19 deaths is seven times higher than at the start of the third wave and still growing on the rapid rise in Covid-19 underway. There is evidence of some weakening in some areas of the US economy as Covid-19 cases climb.

The rand currently averages R14.64/USD and is on track to average R14.55/USD for the quarter, if not slightly stronger, as the rand continues to attempt to pull towards R14.00/USD. US economic data releases will continue to remain key. 

A more cautious sounding approach on US monetary policy from Friday’s Jackson Hole Symposium transpired versus market expectations, particularly on the implications for asset purchases (for weaker, i.e. more dovish, tapering) and this assisted the rand.

A number of the most recent US data readings have proved significantly weaker than expected, notably retail sales, business confidence reading from the Philadelphia Fed, Empire state and ISM manufacturing conditions readings and nonfarm productivity.

With the US third wave not yet having peaked, and new US Covid-19 deaths are over triple since its start, and accelerating, the Jackson Hole Symposium did show concern on the rapid rise in Covid-19 underway and related recent softening in some areas of the economy.

Indeed, the rapid acceleration of infections has worried many, with just over half the US fully vaccinated and worries abound on the effect of tightening restrictions up again given the strong anti-lockdown sentiment in some quarters which may risk riots.

This affected August’s U Michigan sentiment reading on consumer attitudes and expectations towards personal finances, general business conditions and market conditions or prices, yielding a reading that was the lowest since 2011, at 70.2 versus 81.2 the month before.

As such, the reading was lower than any level during the pandemic last year and evidences the disappointment and frustration many now feel towards the third wave, when most had thought the pandemic was past.     

Friday’s Jackson Hole symposium showed a more cautious sounding approach on US monetary policy, and implications for asset purchases, assisting the rand, which is amongst the top performing EM currencies since both the start of the year and Friday.     

Risk-on has improved reflective of some increased investor appetite for yield, and for so riskier asset classes, and the rand will likely track back to R14.55/USD this quarter, and indeed strengthen beyond that, although market sentiment will be key.

While US monetary policy has indicated its tolerance of higher inflation and inflation expectations, markets worry over the jobs market and this week’s nonfarm payrolls figure’s outcome will have the potential to cause marked rand volatility.

The domestic currency lost close to a rand since the start of the month, weakening as markets continue to see early QE tapering, while Covid-19 cases spike in the US in its third wave. However, no new lockdown restrictions in the US have been envisaged so far.

The third wave of new Covid-19 infections in the United States is accelerating faster than its second wave last winter, but Dr Fauci, chief medical advisor to President Biden, has been reported as saying already at the start of August that the US will not ‘lockdown’ again.

Adding at the time "things are going to get worse" as the Delta variant spreads, with "not enough (vaccinated) to crush the outbreak, but I believe enough to not allow us to get into the situation we were in last winter” with a worst reported new daily case recording of 300,777.

On the 16th of August this year, the US saw a new daily case’s recording of 259,493 infections, with the seven-day average at 142,414 then but rising since, and the first leg of the US’s third wave has seen a significantly steeper acceleration than occurred in its second.  

While August’s US conference board reading is not out (due at the end of this month), August’s U Michigan sentiment reading already showed a dip in consumer confidence as the rapid acceleration of infections worried many, with just over half the US fully vaccinated.

Globally there have been marked protests against Covid-19 lockdown restrictions, and with the US having opened up, worries abound on the effect of tightening restrictions up again given the strong anti-lockdown sentiment in some quarters which may risk riots.      

The July FOMC minutes showed strong confidence in the recovery of the US economy and the labour market at that time, with this week’s Jackson Hole communications expected to give strong guidance to the advent of tapering, although risks abound from Covid-19.

Additionally, a number of the most recent US data readings have proved significantly weaker than expected, notably retail sales, the business confidence reading from the Philadelphia Fed, Empire state and ISM manufacturing conditions readings and nonfarm productivity.

With the US third wave not yet having peaked, and new US Covid-19 deaths already triple since its start, and accelerating, the Jackson Hole Symposium could show concern on the rapid rise in Covid-19 underway and related recent softening in some areas of the economy.

The rand has been volatile, weakening on fears the US will hike interest rates before 2023, but pulling back on lower US U Michigan and CPI readings and on reassuring comments from SA’s Finance Minister, Enoch Godongwana on policy continuity in fiscal restraint.

South Africa’s new Finance Minister in particular highlighted that non-interest expenditure will be reduced to 4% of GDP with a primary focus on the cost-cutting coming from government’s wage bill, and that there will be continuity in the fiscal policy trajectory set by Mboweni.   

He said, "We come from the same party; we do not have different mandates, and from that perspective, there will be continuity in terms of the sustainable fiscal path he (Mboweni) has chosen."

"As things stand, I do not see any changes in the fiscal framework."

Minister Godongwana’s political seniority and leadership style will aid in his ability to communicate clearly, with a likely interactive style, the ANC’s position on fiscal policy restraint, and aid his ability to say no, where needed, in the face of expenditure pressures.

The Finance Minister also said there will be no tax increases over the medium-term expenditure framework, which is from the current fiscal year of 2021/22 is 2022/23 to 2024/25. The rand doubtless gained some support from all his comments, as did the bond market.   

He further underpinned the need for structural reform, increasing skills capacity instead of introducing the controversial basic income grant (BIG), tying in with government’s plan of boosting township economies, which would have the benefit of adding to revenues.    

A more co-ordinated policy stance communicated from all areas of government will boost business confidence, which already will have likely received some support from the new Finance Minister’s reassurances, in turn positive for economic growth and job creation.  

The rand however continues to be buffeted by international forces, weakening as market expectations of a 25bp hike in the Fed funds rate in December 2022 solidified, but pulling back as US CPI inflation showed the transitory nature of some of the recent price pressures.

The domestic currency averages R14.55/USD to date this quarter, with further volatility likely. The rand could pull stronger towards quarter-end, and into next quarter, although long-term is still likely to still be at risk of weakness.

Recent rand volatility reflects a bubbling risk-off sentiment in global financial markets amidst concerns that US monetary policy stimulus could be wound back.

The US Federal Reserve Bank highlighted at its FOMC meeting almost two weeks ago that it would keep monetary policy highly accommodative until US employment reached its maximum levels, highlighting at the time that it believed labour participation was low.

However, Friday’s drop in the US’s unemployment rate for July, to 5.4% from June’s 5.9%, was well below the expected 5.7%, while US nonfarm payrolls’ tally of new jobs at 943,000 was well above the 870,000 expected.

The US labour force participation rate, however, did not see much change. It inched up from 61.6% in June to 61.7% in July, which is not a significant enough increase to suggest that a change in the US monetary policy stance is imminent. Since 2015, labour force particpation has typically been above 62.5%. 

Consequently, markets likely overreacted to Friday’s US jobs data. Should this assesment prove correct, the domestic currency may have room to strengthen as risk aversion eases. But markets are not yet leaning in this direction, apparently taking their lead from the straight payrolls figure. 

The domestic currency has so far averaged R14.53/USD this quarter: fractionally weaker than the expected average.

Last week Thursday night the rand briefly spiked to R14.76/USD on Tito Mboweni’s resignation as Finance Minister, only to recover lost ground on the news he was replaced by Enoch Godongwana, who is reported to be against increased expenditure or taxes.

However, it remains to be seen what stance the new minister will take regarding SA’s government finances. This uncertainty, added to the rand's sensitivity to US economic data and ongoing concerns about the global spread of the delta variant of Covid-19, portends further volatility in coming weeks.

The rand currently averages R14.53/USD this quarter, typically the worst quarter of the year for the domestic currency, which historically has seen strength in the first and last quarter of the year and weakness in the middle two.

The sell-in-May and-go-away effect which has been the driver for this typical seasonality has been muted to such an extent it has been barely noticeable, although it has made some showing in August now, the month often most afflicted by this risk-off phenomenon.

With Q1.21 averaging R14.96/USD, and Q2.21 R14.13/USD, the seasonality of the sell-in-May and-go-away effect of the Northern summer holidays (where investors reduce risk as they take their annual large vacation break) has been eroded. 

For the rand this has been due both to the particular severe strength of commodity prices in Q2.21, but also to less risk-aversion than in other years as lockdown restrictions, travel bans, fear of contracting Covid-19 and vaccine hesitancy have all weighed on traditional travel.

Instead, the rand took its weakening cue from the June FOMC meeting, moving into the R14.00/USD to R15.00/USD range on FOMC member expectations of a quicker US rate hike trajectory, from the R13.00/USD to R14.00/USD it was in.

The rand would have seen substantially more weakness were it not for the support it has had from still elevated metal prices (even though metal prices dipped slightly in July), causing the rand to see less support against the FOMC impact which pushed it towards R15.00/USD. 

Indeed, the rand moved very close to R15.00/USD around the July FOMC meeting, but has each day seen mild subsidence, from its worst of R14.997/USD to R14.61/USD yesterday, as the domestic currency pulls closer to the R14.45/USD mark.

However, August is likely to be a risky month for the domestic currency, which could see further marked volatility, while September is a month which has seen marked churn in the past. However, the rand could still see further subsidence from current levels. 

While the US GDP figures are nuanced, they are not sparking risk-off either, and indeed, likely to allow some risk on appetite, with the Fed itself also communicating no need to rush and move away from its highly accommodative stance despite FOMC member views.

The rand dropped to R15.00/USD today amid global market concerns about the spread of the delta variant. Other commodity-linked and EM currencies were similarly weighed down by the risk-off mood.

South Africa is already ahead of the curve with its third wave rapidly subsiding. Cases in Gauteng (the most afflicted province) are down to below 4 000 a day, while overall the country is now at 9 718 new daily cases, from 11 215 a week ago.  

The Western Cape saw notable increases: 2 516 new cases on a seven-day rolling average compared to 2 350 a week ago and 1 619 at the start of June. KZN cases also rose, to 1 375 from 752 a week ago. All other provinces are below 1 000 a day.

Also afflicting the rand from a global perspective is rising nterest rates in EM economies, with Russia recently hiking by 100bp in response to inflationary pressures. South Africa, however, has seen CPI inflation subside: from 5.2% y/y in May to 4.9% y/y in June.

SA’s CPI is likely to see a further drop in July, as base effects continue to wane. But any drop will likely be moderated by a petrol price hike of around 80c/litre due to rand weakness and higher oil prices. The index will likely land between 4.7 to 4.8% y/y compared to the 4.6% y/y previously anticipated.

After staying on hold at the last MPC meeting, the SARB eased its interest rate hike forecasts by about 25bp for this year and 9bp for next year, with 2022 negligible at only 1bp.

Markets will be looking for guidance from this week's FOMC meeting. While the Fed is widely expected to leave its rates and pace of QE unchanged, any indication of a pullback from the current accommodative monetary policy stance will likely exaccerbate risk-on sentiment. Conversely, a more dovish tone would soothe market concerns over global growth despite the resurgence in Covid-19 infections.

The rand strengthened to R14.36/USD in the early hours of today as thin foreign trade saw the domestic currency being lifted by the positive commodity sentiment still at play, but the domestic currency has weakened since then to R14.52/USD.

The widescale riots, looting and destruction of property in certain areas in South Africa last week as infrastructure was destroyed through arson and other deliberate criminal activities continues to negatively impact the rand now that SA markets are open.

The Covid-19 delta variant, which spread rapidly in SA and in some other EMs, continues its spread around the world, negatively affecting financial market sentiment as well, given the highly contagious nature of this new strain.

Commodity prices are still at elevated levels, despite some consolidation, which has also aided the rand as South Africa remains a key commodity exporter and suppressed economic activity after last year’s harsh lockdowns have limited imports, benefiting the rand.

The damage to SA’s infrastructure will see a further curtailment in economic activity, over and above that lost in the past week from the riots incited by the previous regime’s hardcore supporters, which combusted into opportunistic looting and was fuelled further by poverty.

Appetite for fixed investment in South Africa has also taken a hard knock, as will consumer and business confidence, and even the appetite for some to remain in the country, particularly for the high-income groups which are internationally mobile. 

Loss of investors and skilled individuals, both of which usually characterise the internationally mobile residing in SA, even for those whom it takes longer to emigrate, would also negatively impact the future economic prospects for the country, creating a negative cycle. 

Such is the impact from a severe elevation in political risk for any country. SA risks not bringing the political risk sufficiently under control, with the slow response from state security forces seeing some in the private sector having to defend themselves and their property.

The rand has seen some volatility from all these factors, with rising Covid-19 numbers impacting EM currencies in particular (SA’s are still moderating), but SA would lose out by lagging further behind global recovery now as well, which will tell on the rand in future.

In general, risk-off sentiment has had some negative impact on EM currencies, as market players worry about global economic recovery as Covid-19 cases rise internationally, resulting in some risk-off and some US dollar strength on safe haven flows.  

Against this backdrop the rand has made noticeable gains since its low of R14.79/USD on Wednesday last week when South Africa’s riots spread, raging out of control until military action and private sector self defence mobilisations (in the main) arrested further insurgence.

However, many in poor communities tried to gain some items too. A devasting impact of the lost decade of 2010 to 2019’s collapsing growth and state institutions under state capture has been on the poorest of society, and this added to the riots’ momentum. 

Calm has been restored on many fronts, with policing now very active, and the military in place to also fend off attacks on strategic key points such as harbours, electricity substations, water treatment plants etc, attempted attacks to radically destroy the economy.

The relatively quick shutdown of the insurrection (as termed by President Ramaphosa), has been key in aiding the rand’s recovery, evidencing collective determination by the majority not to let the country and economy collapse, although the threat from insurgents is not past.

The tail effect from the insurgency, and ensuing participation of some communities and/or community members on sentiment, will be negative and risks being long lasting, dissuading tourism, both domestic and foreign to some degree, and further cutting off economic activity.

SASRIA payments need to urgently be actioned, those without SASRIA cover should be compensated by the state to restore economic activity, jobs and livelihoods as soon as possible, allowing the negative effect on South Africa’s collective psyche to be shrugged off.

The aim of the destruction by the instigators was to create fear, chaos, extreme disorder, undermine the Ramaphosa Presidency and the country at large, and was intended to spread throughout South Africa, burning productive capacity to the ground.

Preventing further destruction of the economy, and so of livelihoods and lives should be paramount now. Growth enhancing reforms must finally be implemented quickly, and strong market orientated, growth perused, while populist, nationalist polices are discarded.

The rand is averaging R14.31/USD in the first couple of weeks of Q3.21, but has traded at R14.50/USD so far today (R17.18/EUR and R20.10/GBP) as the incarceration of former President Jacob Zuma sparks unrest and looting.

The rand weakened in response to the widescale riots and destruction of property in certain areas in South Africa as the disgraced former President’s supporters are reported to have closed off some roads, set fire to certain shops and looted electronic and other retail goods.

While police action has been noted in some areas, other spots have seen little intervention. If left to continue unchecked, impact on South Africa’s overall economic activity, business and consumer confidence in Q3.21 could be severe. With the economy already under pressure from tightening lockdown restrictions at the turn of Q2.21 into Q3.21, growth forecasts may now be further downgraded.

SA risks seeing economic growth of less than 4% y/y this year if key CBDs, retail shopping malls and road transport routes remain closed, and particularly if the violence spreads as Zuma supporters and opportunistic criminal element bring economic activity in a number of areas to a standstill. 

It was reported earlier today that the army will be deployed in Gauteng and KwaZulu Natal to assist the thinly-stretched police force.

Supporters have appeared to expect little or no real retribution so far. The risk is that the collapse of law and order spreads across the entire country, shutting off the economy and making it more difficult to roll back from the initial violent outbursts (not the base case).

If more individuals join in to gain the spoils to be had from looting any and all retail outlets, it is likely that appliance, clothing, food, and other retailers will become targets. 

Apart from losses faced by the private sector, the volatile situation, if not rapidly brought under control, will quickly begin to impact investor sentiment, threatening to derail the hard-won gains in the Ramaphosa presidency.

The rand began the third quarter of this year at R14.42/USD, then went on to strengthen to R14.25/USD, R16.91/EUR and R19.74/GBP. We expect an average of R14.35/USD this quarter, although SA remains at risk of falling behind the global recovery due to its relatively slow vaccination rollout.

Key economies such as the US have covered 50%+ of their populations with effective vaccination against Covid-19, bolstering global financial market sentiment of a persistent economic recovery. According to the IMF, US growth of this year will be around 7%, after last year’s -3.5% y/y. And growth is expected to continue beyod this year, with the IMF forecasting 4.9% y/y for 2022. This on the back of fiscal stimulus aimed at infrastructure investment, boosting the productivity of the labour market, education, R&D and childcare

The broad gamut of US planned expenditure includes the American Jobs Plan (AJP) and American Families Plan (AFP). State expenditure is expected to increase by around US$4.3trillion over the next ten years, although there is uncertainty about the timing.

The IMF expects that the plans will add 5.3% cumulatively to US GDP over the 2022 to 2024 period as a strong productivity boost creates more jobs with better wages, thereby reducing inequality and increasing inclusive growth.

The US infrastructure drive is particularly focused on the electricity, telecommunications, water and transport sectors, with a view to reducing capacity constraints and improving productivity in its economy. These goals are similar to those outlined in the South African Economic Reconstruction and Recovery plan, as the country seeks urgently to address productivity constraints associated with inadequate state services.

South Africa saw 26 485 new cases of Covid-19 on Saturday, spiking the seven-day rolling average up to 19,143. This exceeds SA’s second wave where new daily cases reached 21,980 at its peak, and a seven-day rolling average peak of 19,042 -- higher than the first wave.

Gauteng's third wave exceeded the peak of the first two some time ago, and remains the worst-affected province, even as new Covid-19 cases accelerate noticeably in the Western Cape and KwaZulu Natal, with the North West and Limpopo provinces following a smiliar trajectory.

The US fiscal plan has lent the rand some strength. However, headwinds are not limited to Covid-19 and the vaccine rollout. Infrastructure constraints including electricity shortages, and now increasing water shortages in key areas such as Johannesburg, represent a binding constraint on economic growth. Overcoming these and other challenges is further complicated by ongoing corruption, with ongoing efforts by the courts to bring the corrupt to account stumbling in recent days.

With the US Fed signaling possible interest rate hikes this year, a number of emerging market central banks are also adopting a more hawkish approach. The Brazilian real has now overtaken the rand to become the strongest EM currency since the start of the year -- up 6.8% thanks in large part to interest rates increasing to around 25bp below pre-pandemic levels. At 3.5%, SA’s repo rate, in contrast, is a full 300bp below its pre-pandemic level of 6.5%.

Russia too has been hiking its interest rates, by over 100bp, while its currency is the third strongest this year since January, up nearly 3.0%. Mexico’s rate hikes have also supported its peso, as have Hungary's, whose forint is leading EU rate hikes.

Against this backdrop, with higher inflation stoking higher EM interest rates, SA’s SARB governor also appears to be adopting a more hawkish outlook, indicating that the economy is seeing a stronger than expected recovery, and that inflation could nudge interest rates higher. This even as a third wave of Covid infections, and resultant tighter lockdown measures, presage slower economic growth.

The adjusted level 4 implemented last night is predominantly aimed at limiting or eliminating gatherings by encouraging people to work from home, closure of schools and numbers at funerals now limited to 50 with no night vigils. Interprovincial travel is limited, and alcohol sales banned, which will negatively impact the hospitality, tourism and restaurant sector, with many businesses not recovered from last year’s lockdown.

With the highly contagious delta variant seeing infections higher than in the first two waves, government is scrambling to contain contagion within Gauteng and prevent a similar surge in other provinces.

The slow progress of SA’s vaccination drive, which has so far reached only 4.5% of the population, is also being held up by little to no vaccinations over the weekend due to insufficient government funds. This amidst fresh instances of corruption and theft of state funds, even in the health sector.

While we still expect no interest rate hikes in South Africa this year, the SARB has started talking of normalising monetary policy, which, combined with the negative impact of the third wave and higher restrictions, will slow the pace of economic recovery.

The rand weakened to R14.38/USD after last week’s FOMC meeting, negatively affected by the increased hawkish nature of US FOMC members’ interest rate forecasts as well as the ongoing high rate of new COVID-19 infections in SA’s key economic province, Gauteng.

Despite some placatory comments from Fed Chair Powell that the elevation in individual FOMC members’ interest rate forecasts (the dot plot chart) in 2023 should not be taken as a given for the future rate hike trajectory, the dot plot update nevertheless reduced risk on.

The majority of EM currencies are weaker on the year, with the ZAR still leading the emerging market (EM) Bloomberg currency ranker, but this is mainly due to its extremely weak base of a year ago when it was the worst performer out of this EM currency basket. 

The platinum price is up 27.1% y/y currently, seeing less annual strength than in June before last week Thursday’s FOMC meeting when the platinum price ran consistently above 40% y/y,  although still lending the rand some support, which is up 20.9% y/y.  

Markets continue to re-evaluate risk, and foreigners have sold off -R4.5bn in SA bonds since the FOMC meeting and -R5.5bn in equities, both net of purchases with South Africa’s Reserve Bank (SARB) warning on the potential for rand weakness to feed through into inflation.

The SARB governor is also reported to have noted that “(t)he economy is less vulnerable than it was last year –- we have got a current-account surplus and the budget balance has recovered faster than we had actually expected”. 

And further that, SA will be “going into normalisation from a very solid basis”. “That should help the Treasury stabilise debt”, with the SARB likely to hike interest rates if there is evidence of second-round effects from rand weakness in inflation.  

While the SARB is sounding a less dovish tone, and this is likely to help the rand retain some support, SA’s Reserve Bank is also likely to not hesitate to hike interest rates as global monetary policy becomes less accommodative, and rate hikes increase in other EMs. 

While we currently don’t expect any interest rate hikes in South Africa this year, 2022 could well see the SARB begin hiking, given its past hawkish bent, even before the US does, which is currently seen likely to be only in 2023.

The rand has weakened to close to R13.80/USD, negatively affected by the spiking in Covid-19 infections in South Africa’s key economic province, Gauteng, which has shown a phenomenal jump in new cases,  up 78,942 yesterday since 6th May.

There has been a geometric expansion of new Covid-19 cases in Gauteng, and the seven-day rolling average for the country’s most productive province is now close to the peaks of the first and second waves. Load shedding too has been negative for the currency. 

Vaccinations are only at 1,619,011 country-wide in a population of sixty million, with the elderly (over sixty and estimated at around 5,000,000) and health care workers still in the process of being vaccinated as phase two continues overlapping with phase one.

The extremely slow rollout of vaccines, with the department of health having failed to expedite the process to meet the original planned schedule, means that the country will most likely not reach two-thirds immunity by year-end as was originally planned.  

Instead, instances of corruption have been indicated in a number of areas across the public health system as public monies deemed to be used for private gain instead of being spent on the vaccine rollout and in other critical areas.

The take-up of the vaccinations by the over sixties’ age group continues to be relatively weak, with some monies earmarked for advertising and promoting the drive to be vaccinated having been reported as forming part of the looting. 

SA has failed to vaccinate the vast majority of its economically active population, and with deaths now rising rapidly in Gauteng as unvaccinated individuals succumb to Covid-19, there has been little impetus to vaccinate all those over forty who wish to receive it.

That is, the pace of vaccine rollout has proved too slow to prevent the third wave, beset with problems from international delivery on quantity, quality of vaccines received, and suitability, to domestic problems as the drive kicked off late and was exceptionally slow until May.  

While May and June has seen a quickening in vaccine rollout, the pace is still too slow and SA risks substantially more Covid-19 deaths. So far, Q2.21 averages an exchange rate of R14.06/USD, although the rand could weaken further as Covid-19 cases continue to spike.

The last time the rand saw such strength against the dollar was in early 2019. The recent reversal of fortunes in the domestic currency reflects the strength of the trade account, as South Africa’s exports continue to benefit from a commodity price boom.

SA is unused to such strength in the domestic currency. After two decades averaging a trade deficit of close to -R0.1bn, the average trade surplus for 2020 and 2021 to date is R26.5bn, and the average surplus for the first four months of 2021 was R36.9bn. 

South Africa’s terms of trade (the ratio of exports to imports) are strongly positive. Not only has the commodity boom raised the prices for SA’s resource exports, but the rand’s strength has also dulled oil import costs.

The rand also continues to benefit from global growth expectations, which continue to underpin positive sentiment and the risk-on environment, as do supportive global monetary and fiscal policies. 

However, the currency remains sensitive to key US data releases, and we continue to believe that a financial market "taper tantrum" as the US slows its fiscal stimulus measures would not leave it unscathed. Evidence that the US is recovering strongly, particularly its labour market, will likely reduce rand strength.

Friday’s lower-than-expected US nonfarm payrolls figures (559,000 versus expectations of 650,000) consequently saw the rand briefly strengthen to R13.40/USD, before being rebuffed from this resistance level. At the time of writing it was back around  R13.48/USD.

So far, Q2.21 averages R14.18/USD, with our current forecast R14.15/USD. While the rand may prove to average closer to R14.00/USD this quarter, there remains a strong risk of weakness should there be a switch in market expectations on US QE and interest rates.

Any indication that the US is seeking to reduce (taper) its bond-buying programme, reducing the creation of US dollars seeking high yielding investments, would reduce the attractiveness of the rand. 

While inflation has rightly been seen as a key factor in US monetary policy, the Fed is likely to look past the recent jump in inflation, which is largely due to temporary statistical base effects, and instead, focus on employment data. This could see a strong quarter end for the rand, with the risk of depreciation heightening in Q3.

May saw a modest net inflow of foreign investment into SA bonds (R5.9bn) but a more substantial sell-off of SA’s equities (-R7.1bn). But the net outflow failed to dampen rand strength, most likely thanks to strong commodity exports. 

The rand reached R13.73/USD today. It's likely to average R14.05/USD this month, and potentially R14.15/USD this quarter. The strongly supportive global monetary policy environment is also benefiting the domestic currency, as are SA’s interest rate differentials.

The differential between the yield on the ten-year US treasury and SA’s ten-year bond has widened to 7.67% from close to 6.00% in 2018, making SA bonds attractive to foreign investors, although this spread has been narrowing this year. At the start of 2021, the spread between the US and SA ten-year yields was at 8.00% and has gradually worked down to 7.67% currently, with global financial markets also in yield-seeking (risk-on) mode. 

The rand has been sensitive to market expectations on US interest rates and yields, with some inter-day and inter-week volatility, but this has been relatively mild, with the global risk-taking environment a supportive backdrop for both the commodity boom and EM assets.

US yields may see some further lift this year if inflationary concerns worry markets materially again, with the US not expected to keep interest rates on hold indefinitely, and the strength of commodity prices and other supply-side pressures causing some concern.

While the US has seen very substantial fiscal stimulation, with the stimulus cheques US households have been receiving supporting economic activity, the pressure is essentially supply-side in nature with limited true demand-side price pressures. But as wages rise and unemployment winds down, higher demand could trigger the US Federal Reserve to raise interest rates to counter inflation. This is not expected in the immediate future, however, and the rand is therefore on track to retain its strength this quarter.