TreasuryOne Monthly Report and Forecast
Executive Summary
As we look ahead to the next month and the possible movements in the currency markets, we need to surmise the macro factors affecting the market.
Movements in the US dollar are still the primary direction giver in the market; thus, it will be prudent to look at what factors could move the US dollar in short to medium term.
- For the past year, the COVID- pandemic has been the main focus and continues to be as the vaccine rollout gains’ momentum.
- The US economy’s bounce-back will also be critical to the US dollar and, thus, other currency markets.
- How the US Fed treats the threat of inflation and when they expect interest rates to rise.
- The current fascination with all things US Treasury yields.
As we head into Year 2 of the pandemic, we can say, without any shadow of a doubt, that the COVID- pandemic has affected everybody. We’ve seen how the rollout of vaccines and the lifting of lockdowns in certain parts of the US has helped the US dollar in the past month. However, the opposite is also true for the Eurozone, with the single bloc currency nations facing fresh lockdowns over the Easter period. The lockdowns will affect the Euro and provide a shot in the US dollar arm, and we expect the US dollar to be on the front foot in the short term.
The US is in front of the vaccination curve and the result of that is that the US economy will be one of the first big economies to start to churn at almost total capacity. We see this in the median projection of the 2021 GDP out of the US to be around the 6.5% mark. Granted, this has to be viewed in context with the base effect inflating the numbers a little, but then again, the US economy will be ahead of its developed market peers.
To aid the US recovery, we’ve seen the new administration implementing a 1.9 trillion-dollar stimulus bill. The expected fallout from the stimulus was for the US dollar to weaken and Emerging Market (EM) currencies to enjoy the umpteenth wave of fresh money hitting their combined shores. This was the initial reaction to the news, but the market took a step back and asked what the long-term impact of the fresh stimulus could be. The market tried to call Fed Chair Powell’s bluff when the Fed Chair stated that rates would be lower for longer as the market expects inflation to be the next major driver of US monetary policy. The expectation is that there will be a blip in inflation in the near future that will force the Fed’s arm to start raising interest rates. In contrast, the Fed has been punting the unemployment rate as key to their strategy with interest rates, whereas the market punts inflation to front-run unemployment.
The fact that the market is calling the Fed’s bluff could be seen in the movement of the US Treasury yields of late. Yields have been the major driving force of the US dollar in the past month as Treasury yields have been rapidly increasing and making the US market far more attractive than it was at the start of the year. We’ve seen the US treasury yields retreat of late, but the US dollar has a four-pronged attack on the market at the moment, with each of the prongs suggesting that the US dollar is in for a bit of strengthening as the rest of the world is playing catch up.
In looking at the Rand specific movements, we have to look a little broader at what is happening in the EM space at the moment.
- The expectation that Chinese production is set to pick up in March
- The kite string that has been cut in Turkey and new political drama in South Africa could cost the Rand
- COVID and the slow rollout in EM and the possibility of subsequent waves.
Economic recovery will be a key phrase as the COVID pandemic starts to dwindle, and one of the measures will be the production that happens out of China, as China is the central engine of the EM market. We have seen production dwindling after the November highs, but we expect the March numbers to improve as February had been affected by the Chinese Lunar New Year. A steady improvement in China numbers will start to filter through to other EM’s, and the EM’s need a robust China for the market to feel that EM’s are a safer bet. This may take a bit of time which could mean the EM’s will be under pressure in the short term.
As evidenced by the Turkish Lira weakness, it is easy for one of the EM currencies to be sent adrift from the rest. Firing your Central Bank Chief is a bit drastic, but nothing in Turkey seems to go down without fireworks. In the past, we saw that the Lira and its massive movement affect other EM’s, but it seems that the market is starting to compartmentalise countries in the EM basket.
So what will be the critical issue that we think will plague the Rand in the coming months? The slow vaccine rollout in South Africa as it will cause us to lag in opening our economy safely from other EM peers. Luckily, most of the EM countries are in the same boat, and the effect is limited, but should we fall behind, it can cause a bit of country-specific event. Lockdowns will continue to plague the country and puts more strain on an already fragile economy, and this is not the best look when trying to attract foreign investment.
A further blot on the South African copybook is the latest round of political uncertainty due to the mess we saw at the ANC NEC this weekend. The meetings descended into chaos as Ace Magashule said that he would not step aside despite the ruling party asking him and other members facing corruption charges. This has the possibility of driving a wedge in the ruling party and could see the wafer-thin majority that President Ramaphosa have, crumble and crack the ANC. While nothing has filtered through to the markets, this could be one of those cutting the cord moments if we are not careful in South Africa.
In saying all that, we believe that the US dollar will be the compass for currency markets at the moment, and we do think that buying the US dollar below the R14.90 level is a prudent strategy in the short term for importers. We expect the Rand to start losing a little ground to the top end of the R14.70/R15.50 level, and exporters should see any level near the top of the current range as a definite opportunity to start hedging.
Below the USDZAR chart showing the trading range for the past five months
