TreasuryOne Monthly Report and Forecast
Any analytical exercise and subsequent forecast generation concerning is a subjective and multi-faceted affair. At the same time, we consistently bring to the table our quantitative and data driven methodology that has served us well in the past.
Our current monthly reviews the Rand on a long-, medium- and short-term basis.
Long-term the currency’s future is dire. Spiraling government deficits and debts as far as the eye can see underpin a forecast that the currency’s future is bleak.
The medium-term is clouded by an increasing sense of disappointment in the Ramaphosa government. Substantially it is proving to be no different from the Zuma regime.
In the short-term the Rand though is at a crossroads. A triangle formation has developed since the highs of the Rand in April. The currency has retraced 20.00% from those levels, facilitated by overall risk-on trades taking place in various capital markets.
Once the triangle formation is exhausted, a period of extended volatility usually ensues. There are considerable political and economic risks to navigate over the period to the end of the year.
The US election promises to resemble the worst elements of a Third World’s chaotic fight for sustaining a dictatorship, rather than a smooth transition of power in the world’s oldest democracy.
In Europe mainly, but also in other parts of the world, Covid-19 infections are re-appearing in second waves, knocking over and challenging assumptions for the pace of economic growth. Economic vulnerability is a global phenomenon now.
The Rand will face pressures over the next 3 months to be sure. If government does not reassure that they have got a grip on our economic realities, then the Rand will surely take pressure.
Risks to the South African Economy and Currency
Since the publication of our last monthly, the Rand has stabilised within a relatively wide trading range.
Price action has followed a familiar and well-worn incantation periods of grinding lower followed by short sharp bursts higher.
The overall trajectory has been moderately biased towards Rand appreciation. This partiality has been facilitated by generalised weakness of the US Dollar in international markets since late September.
From a technical perspective, the Rand is currently hemmed in by two key levels, resistance at 17.3000 and support at 16.0000. Both have been tested in the last month, but rejections of both points have led to sharp retracements towards what is now becoming a familiar zone of 16.5000 – 16.7500.
Dollar Rand Monthly Data Series & Big Picture
The chart above illustrates the extent of Rand devaluations against the US Dollar over the last decade. Ramaphosa’s election at the back end of 2017 has provided any fleeting relief to the currency.
Dollar Rand Daily Data Series
South African Government Bond Markets
The South African bond curve has steepened in recent weeks, which bodes ill for the effective funding of the government’s budget deficit which is expected to expand rapidly in the next three years.
South African Yield Curves – January to October 2020
The obvious temptation for National Treasury’s Debt Management Office is to tap the short end of the curve leaving it with significant roll over risks if the curve steepens further and/or inflationary pressures start to emerge.
International investors have displayed a loss of appetite for rand-denominated fixed income risk. At the same time, there is little capacity for local funds to absorb not only that opening demand gap but also take up the additional supply which is sure to hit the market in the coming years.
No wonder then that term yields are backing up.
Sidebar on the Turkish – A warning for the Rand
The Turkish Lira has been the big attention grabber in the emerging foreign exchange market over the last two years. Since the beginning of 2020, it has really put the skids on depreciating 44%.
The Rand at its worst in April had sold off 39% while currently, it is only 19% weaker than at the beginning of the year.
How grateful should we be to be living in a non-strategic corner of the world.
Little more than a decade ago, South African Debt to GDP was below 30%. By the end of 2022, that ratio is expected to have reached 82%. Opportunity squandered. Again!
As we recounted last month the most threatening aspects associated with South African public finances is the increasing share of expenditures being consumed by debt servicing, public sector salaries & the collateral burden imposed by failed State-Owned Entities (SOEs).
Tito Mboweni’s Medium Term Budget Speech will be tabled with Parliament on the 21st of October. Eagerly anticipated by extremely unlikely to contain any good or reassuring news. We will cover that is some detail shortly after its publication and the likely impact on the Rand and sovereign interest rates.
The growth in central government debt together is unequivocally the largest existential threat to the South African economy and thence the Rand.
To attract international portfolio flows to fund government expenditure, SA government yields will have to rise, the interest rate channel, and/or the Rand will have to depreciate, the currency channel.
The currency may have to give.
US Dollar Outlook
The United States, like South Africa, has run persistent current account deficits, almost unbroken since Richard Nixon was in the White House 50 years ago.
Since the US Dollar is the world’s reserve currency, the Americans have not been obliged to hold Foreign Exchange reserves.
To cover their debts, they merely print dollars. Quantitative Easing is just the latest manifestation of that machine.
Also, the current account deficit has been funded by capital inflows attracted by superior returns offered by US equities and bonds.
When the inevitable rainy day appeared this year, net savings, (government, corporate and household) turned sharply negative.
As the graphic below illustrates, consequential US Dollar vulnerability is not a new phenomenon. It has been baked in for decades ago as savings have been plummeting since the 1960s.
Living beyond their means? For sure.
Negative consequences for the US Dollar? For sure.
Congress and the White House have committed themselves to another round of fiscal stimulus, of anywhere between US$ 1.5 trillion and US$ 3.0 trillion.
Even without that flood of restitutive spending Federal Deficits had looked set to soar in the coming decades.
To attract international portfolio flows to fund government expenditure, US government yields will have to rise, the interest rate channel, and/or the Dollar will have to depreciate, the currency channel.
The Federal Reserve has committed to keeping rates at zero for the next few years, effectively closing the Interest Rate channel.
The currency may have to give.
Real Broad Effective Exchange Rate for United States (2010=100)
The US Dollar is priced considerably higher than it was prior to the development of the European Sovereign and Banking Crisis. When viewed in isolation, the US Dollar appears vulnerable. However, when observed against the Euro in isolation, that weakness may be overstated.
With interest rate regimes in both economic blocks at virtually identical states, the relative health of the banking systems becomes a more significant factor. The Euro Stoxx Banking Index is still 85% lower than it was in 2007. US Banks are comparatively far stronger.
Financial Risks posed by the US Election
We have entered the last three weeks of the Presidential and congressional of campaigning for the election in the United States. As the world’s only superpower, the decisions made by Americans will nevertheless have an impact on all of us.
As things stand, Joe Biden (Democrat) has a strong and stable lead over the incumbent, Donald Trump (Republican). Surveys and continual polling indicate that Biden has a 10% – 20% lead, nationally.
For key swing states, Florida, Texas and Ohio, the lead remains much narrower.
The deciding issues appear to be: Trump’s record as a President in managing the pandemic and the economy.
His electoral vulnerability is coming from losing the confidence of the over-65’s who have felt most threatened by the pandemic and suburban women who have been alienated by his aggressive style of governing.
Covid-19 Stimulus Bill has become a political football
The on-again, off-again budget negotiations have whipsawed the markets.
The Democrats are falling in behind proposals which are comprehensive in nature. The bill from their spending plans looks to total almost US$ 2.2 trillion.
The Republicans, at last count, have raised their proposed spend to US$ 1.8 trillion. The Trump administration is anxious to conclude a deal prior to the election; naturally. Senate Republicans have in the main resisted larger spending beyond US$ 1.0 trillion.
Our view is that the deal will be done much closer to the Democrat’s numbers as the Republicans are the more desperate to conclude and sell to the electorate as a political win.
Rosenberg Research compiled comparative Bid/Trump Indexes, based upon various subsectors within the S&P 500. The equity market has begun to discount a Biden victory.
Source: Rosenberg Research
So far, the US Dollar and other major currencies have not appeared to be unduly influenced by the US Election. That said currency option volatilities remain elevated, especially in the period surrounding November 3rd.
The Rand is sitting at a crossroads. Technically a strong argument may be made for further Rand strength against the US Dollar and even the major European crosses over the next 6 months.
This would be consistent with periods of calm that persisted after successive violent moves to the topside in 1998, 2001, 2009 and 2015. Against that the international economic environment is far more threatening than at any time over the last 20 years. South Africa also has many self-inflicted weakness’s which would put a limit on overly rosy prospects.
The US Dollar also faces its challenges. Decades of relative dissaving and ‘relying on the kindness of strangers’ to fund current account deficits have left it exposed. To the extent that it calls for an imminent collapse and relinquishing its reserve currency status is overblown, not least because there are still no realistic alternatives.