By Neels Heyneke, Macro Strategist and Andre Botha, Senior Dealer
Over the past couple of weeks, we have seen the rand doing its best impression of a rollercoaster. Emerging markets have come under pressure from a stronger US dollar, the Fed taking centre stage with talks of taper, inflation, supply chains and possible rates hikes talk. This has led the rand to trade up around the R15.20 level only a matter of a couple of weeks ago.
Because economies are inherently interlinked, inflation has received a lot of attention as a result of the events described above. The QE program has been blamed for inflation, as have supply chain issues, which by their very nature will drive inflation up. The fundamental question right now is when inflation will return to the various central banks’ targets. With little in the way of history to guide us as to how the inflation narrative will play out, the market is believing the transitory call from the Fed for the time being. However, we have seen in the recent weeks that the bond market is starting to call out the Fed that inflation will be here for longer
The chart above illustrates how uncertain the market is at the moment with the Dollar Index caught between a narrow band of 94.75 and 93.49. This heightens the significance of the FOMC meeting next week when the market will receive a sense of the Fed’s stance on tapering. Our analysis suggests the Fed will err on the side of easier monetary policy, a weaker US dollar and a break of the 93.49 mark. The 10-year treasury is currently trading at 1.73% and could test the 2% mark if the market believes the Fed is too dovish.
A curious thing happened, and the rand and other emerging markets began to recover some of their losses quite fast, despite no significant movement in the US dollar, which is/was the recent driver of emerging markets. Whether the risk sentiment shifted as markets shifted through the inflation data and waiting for the Fed to deliver on their promises, or commodity prices giving EMs a shot in the arm is up for debate, and we will probably find it a smattering of the former and a helping of the latter. Whatever the case may be, the rand moved back the R14.40 in a matter of a week.
However, in the last few days, we’ve seen an old familiar face in the EM space resurface. Turkey and its economic position influenced EM risk sentiment a few years ago, when President Erdogan fired central bankers, used the interest rate as a yo-yo, and inflation spiked. This cast a negative light on EM, and all EM currencies were lumped into a “guilty by association” basket and came under fire. The same situation has occurred in the past couple of days, with President Erdogan taking a beating over economic and political decisions, with the biggest surprise that he dismissed ten foreign dignitaries from Turkey.
The Turkish Lira, for the umpteenth time, traded at its worst level against the US dollar, and it was only a matter of time before that spilled over to the emerging markets, as the EM basket has been relatively sheltered from Turkey over the past few months. It seems that the contagion effect finally entered the EM market, with the rand reacting to the Turkey situation quite violently, and has traded back above the R14.80 level against the US dollar.
This increases our watchfulness on the Turkish Lira in the short term. We have since learned that President Erdogan has rescinded his decision to expel the foreign dignitaries, which have caused markets to cool down a little. This does not mean that the threat has passed entirely, and we still need to be vigilant for any news from Turkey.
The performance of the US dollar in the movement of the rand has been overshadowed by EM drama, as we have seen the US dollar trade stronger without taking the rand with it. Once the EM story has waned, we expect the rand to follow the US dollar. On the South African front, load shedding has started again, which has become part of the norm, but should the situation change in terms of stages of load shedding, we could see some reaction in the rand.
The above technical chart only illustrates the point that the rand is trading in a relatively tight range and trading in a nice wedge formation currently. Theory on wedges dictates that the break out is normally to the steep side of the wedge which gives us the indication that the rand could trade stronger, however, we have the FOMC next week and our Medium Term Budget speech that could change the fundamental landscape.
The two major releases this week are Quarter 3 Advanced GDP number out on Thursday and the October inflation number out of the Eurozone on the international front. Should these numbers deviate significantly from the estimate, we could see some volatility, but we expect the market to trade in ranges as we head into the end of the month.