The world’s eyes are focused on the US economy and how it will react in the early days of reopening its economy in a post-pandemic world. In April, the US inflation number surged to a 13 year high at 4.2% from a year earlier. The official narrative is that inflation will be transitory and result from Americans having more money in their pockets due to stimulus and spending it on goods they wouldn’t typically buy. This drives the theory that when this (stimulus inflation) washes out of the system, inflation will return to the 2% level, and the Federal Reserve is looking at inflation consistently above 2% to even start looking at increasing interest rates.
A key inflation indicator, the core personal consumption expenditures (PCE) index rose at a faster-than-expected 3.1% in April as price pressures built rapidly. The PCE number spooked the markets, but the US dollar made a slight recovery afterwards as higher inflation means that interest rates need to rise. The inflation number will be under great scrutiny from now on.
Another piece of Fed news currently making headway is the increase in reverse repos by the Fed or, in other words, draining liquidity from the market. The Fed almost hit $500 billion last week, which is about 4 months of QE that has been taken off the table.
There are two schools of thought regarding the Reverse Repo Market. The first is that the market believes that reverse repos are good because that means the system is well capitalised and that the US economy has survived the pandemic. As we head toward normalisation taking liquidity out of the market is expected. The second more cautious school of thought is that the financial system is drowning in liquidity, which is one reason why commodities are sky-high. Excess liquidity is driving inflation, and that US Treasuries are mispriced and should be higher. Should the latter be the case, we could be in for an exciting backstretch towards the end of 2021.
Now that we have set the scene for the significant factors at play in the market, the critical number that the market awaits this week is, of course, the US non-farm payroll (NFP) number that will be out of Friday. In light of the massive miss of the last NFP number, we can expect that this number will be looked over with a fine-tooth comb, and we expect some dollar action after the release. In addition, the US are out of the market today (Monday), which will concentrate movement to the end of the week.
On the rand front, we have seen the rand trading on the front foot along with its EM peers. The rand is by far the best performing EM currency for the year, and the themes of terms of trade and yield-seeking are still firmly in the rand’s favour. We have seen the rand reach a low of R13.68 last week, and it is difficult to see the rand not returning to those levels during the week. We can see from the graph below that the USDZAR has been trading in a downward trend for most of 2021.
However, we still believe that importers should use these levels to get stuck in as we think that the second half of the year could see the rand trading weaker.