Rand still has significant strengthening potential

Rand_currency_2005seriesOver what has been nearly a year now, HA has been drawing the path the Rand will follow to readers.  At this stage of the game, everything is panning out pretty much as expected.  After the US Fed stopped its QE programme in nothing but name, the markets became spooked with the Greek near-default in May.  This saw some Rand weakness, as we had expected.  However, the Rand held up very firmly against the USD even with a near collapse of a member state of the EU, an event that would have created carnage in global markets.

Coming through the Greek turmoil a like General Maximus Decimus Meridius, the Rand recomposed and marched forth.  SA’s budget deficit has been narrowing, interest rates have held fairly steady to lower across the curve, and consumer price inflation has slowed, all symptoms of an economy undergoing some fundamental changes that will come out the other side of the tunnel if left to its own devices.

As we moved into Q3, the global economy entered a growth slowdown phase – not a double dip, but rather part of the first dip that never ended.  As a result, risks of QE2 increased, and what is more, the Rand increasingly became a ’safe-haven’ from the money printing lunacy going on abroad.

As we head into Q4 and then Q1 2011, we expect QE by the majors will be started up again.  None of this keeping the Fed balance sheet unchanged by rolling maturing MBS security principal into the Treasury curve nonsense.  We ‘re talking proper QE, like a quadrupling of the Fed balance sheet QE in a few years here, as one Goldman Sachs senior analyst reckons will be done. This remains Rand bullish.  The SARB is a tiny little central bank with a balance sheet some 50 times smaller than the Fed.  For the SARB to avoid the Rand from going to levels of 3/4 against the USD, it would need to expand its balance sheet well into the trillions and yes, that would imply a repo rate of close to 0% in SA, i.e. a prime rate of 3.5%.

As if QE risks aren’t enough, we have the possibility of outright currency wars to deal with as well, keeping the race to the bottom in motion.  BoJ this week started forcefully intervening to weaken the JPY, by printing more JPY and buying USD with the proceeds, obviously propping the value of the dollar up.  Other Asian central banks are thinking of doing the same thing.  As the Chinese have been buying increasing amounts of Japanese government bonds in recent months, the Japanese are destroying the value of Chinese savings, something China isn’t happy with.  Zerohedge then reported that the Chinese stood on the other side of the trade, buying the JPY that the Bank of Japan was selling to support the value of the JPY.  Through all this, the Chinese yuan has been strengthening against the USD, while US lawmakers continue to take a hard-line on the Chinese for not letting the CNY appreciate fast enough.

In any case, the reality is that the race to the bottom is on and that investors are waking up to the fact that all central banks are essentially trying to see who can destroy their currencies at the fastest rate at the expense of citizens without getting them to notice.  Of course the laws of economics will snap back at the mobster central bankers, but not just yet.  As this continues, gold, which is the ultimate reserve currency, will continue to trend higher into all-time high territory.

The Rand, as a high-yielding currency with a low public debt stock and relatively small annual public borrowing requirements, combined with high private debt metrics, which means there will be little feed-through to private credit and hence, money creation anytime soon, are bullish for the currency relative to the majors.  As G4 central banks short-term interest rates remain at zero possibly for the rest of our lives (at least below CPI inflation), as these economies self-destruct owing to the lunatics in charge of policy-making, the major currencies being USD, EUR, JPY and GBP will continue to be used as funding currencies, i.e. investors will borrow in those currencies to invest in emerging markets like SA.  Furthermore, investors will search for destinations where there are prospects for growth and higher returns, investing their life savings there.  Gill Marcus suggested in her most recent MPC speech that this is already happening, that the structure of foreign investments are becoming more long-term in nature.

My purchasing power is higher than your's...

My purchasing power is higher than your's...

This very act of offshore investors flooding to emerging markets will have the effect of  depressing interest rates in emerging markets.  Whether emerging market central banks like it or not, their currencies will strengthen and interest rates will fall, unless the links with the Bretton Woods 2 monetary system are completely cut. In other words, unless the Reserve Bank decides to back the Rand money supply with something like gold, the Reserve Bank, in order to keep the Rand weak, will need to accumulate foreign exchange reserves in a HUGE way and/or cut interest rates in a HUGE way.  The Reserve Bank has already, and will continue to fight Rand strength with these two measures, but we believe it will be futile, the global market and monetary system will win this one if we stay on the floating exchange rate system of Bretton Woods 2.

Basically, what we are saying, is that the Rand may strengthen so fast, and interest rates may fall so fast in years ahead it will set your hair on fire.  But this doesn’t mean the Rand will be safe.  As the Rand is bid to what may today seem like ridiculous heights to levels of 3/4 against the dollar, perhaps even higher, it will be set up for a dramatic fall as capital rushes back out of SA several years down the line once the emerging market dream comes apart.  Gold remains your place of safety as this disastrous sequence of events play out.

In terms of HA Rand forecasts, not much has changed over the past year so we leave you with several links:

Explaining Rand strength to the non-economist (9 Nov 2009)

For the most part, the current Rand ’strength’ is a function of money printing by the central bankers of industrialised nations, who have debased their currencies relative to other currencies that have not been debased. The economic reasoning is simple: an increase in the supply of a currency, all else equal, must lead to a lower exchange value relative to a currency or commodity that has been left in relative fixed supply. Although this is a simplification for brevity, this is the causal relation for the current level of the Rand.

Quality and quantity: A powerful currency prediction framework (4 Dec 2009)

With no new rand’s currently being printed out of thin air, and a vast wall of dollars being created and pumped into the system (quantitative easing), and with the rand’s quality not deteriorating while the dollar’s quality is being hammered, the rand is likely to not only stay strong, but keep getting stronger against the major currencies.

Where can we go in 2010?  Below R7.00/$?  Definitely.  Below R6.00/$?  Probably.  Below R5.00/$?  Very Possible.

SARB balance sheet, Rand, and Gold (6 Jan 2010)

The SARB’s foreign reserves will keep growing slowly in h1 2009, but at some point a USDZAR that drops below 7 and then 6 is going to be enough of an irritation to the political establishment that aggressive reserve building and a lower repo rate will follow, maybe toward Q3/Q4 2010 and certainly in h1 2011. The very low price inflation in 2010 will act as the excuse for this behaviour. So, the rand price of gold could stabilise for most of 2010, but when the USD slide really kicks in and gold runs, coupled with a flood of new rand into the system by h1 2011, so XAUZAR will climb strongly in 2011 and beyond.

SARB betting on a strong Rand in 2010? (8 Jan 2010)

In other words, the SA central bank is biding its time.  It knows the rand will get much stronger in 2010 and allow it to get far more bang for its buck in accumulating forex reserves.  As the USD-ZAR heads back below R7.00/$ and then moves toward R6.50 and R6.00, then watch the SARB ramp up its forex buying in the market, possibly to well over $1-2 billion a month.

Rand is setting up to surprise in 2010 (12 Jan 2010)

It will be interesting to see what our Reuters poll participants come out with in December and January 2010; just in November 2009 the 20 ‘pollsters’ came out with a median (and mean) forecast for the USDZAR of 8.05 (and 8.12) in 2010. Our core view remains for an average USDZAR of 6.40 in 2010. We foresee a high probability that the Rand runs to 5.50 or lower in 2010, but that at this point local industry and policymakers will be publicly wailing and gnashing their teeth, in the process providing ammo and authority to the SARB to step in and forecefully manage the value of the Rand weaker.
[Ed note: the SARB started intervening even before we broke below 7.00, through foreign currency swaps and Treasury foreign currency accumulation.  Absent this intervention we would have been closer to 6.00 by now]

QE2 and its implications for the Rand (26 Feb 2010)

As a result of these poilcies, we expect the Rand will appreciate strongly against the GBP, USD, EUR, and JPY once QE (debt monetisation) is resumed (begins in earnest). We expect this move lower could take place as soon as Q2 or Q3 2010. If uncertainty surrounding QE2 rears its head in March 2010, we expect there will be a sell-off in so-called ‘risk’ assets which would drag the Rand lower in the short-term, but this would only further increase the probability for QE2. Either way, we expect the Rand will hold its ground against the likes of the GBP despite weakness against the USD. Toward the end of 2010 the trend for the Rand remains stronger against these majors. While our target for an average USD/ZAR of 6.40 in 2010 might look a bit far-fetched at the present time, wait until you see the market’s reaction to the realisation that QE2 will be supporting government spending, not asset markets. We think it will be significant and lead to a significant re-pricing of EM currencies.

CPI inflation is dead, for now (30 Jul 2010)

We also previously noted that the SARB will cut rates by another 100-200bps before the easing cycle is through.  Talk of raising interest rates is waaaaay premature, there is no way the SARB will tighten if the Treasury is out in the market buying foreign currencies, (which has slipped under analysts’ radars as the government changed its intervention tools) in order to weaken the Rand.

Treasury is buying forex to weaken the Rand, and if the SARB were to increase short-term interest rates, it would better the yield differential for foreign investors and likely see the Rand strengthen even further.

If it hadn’t been for the government’s reserve accumulation, the USD-ZAR would most likely be trading comfortably below 7.000 at the moment.  Nevertheless, we still expect the ZAR will scream stronger toward year-end, as sound fundamentals remain in place for ZAR strength.  What will really see the Rand get its groove on will be QE2.

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