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This seems like the wrong time to extrapolate currency weakness. Our “extreme peaks” model, which focuses specifically on large moves in the currency, such as the move we have witnessed over the past three weeks, still puts the fair value within the R16,20-16,70 range (Exhibit1). At the same time, the current value of the rand is edging towards three standard deviations above our model trend. This would be consistent with previous “extreme peaks”, when depreciation slowed and appreciation or “normalisation” kicked in (Exhibit 2). Strength from here is not guaranteed, but our model does suggest that now, with the rand in the R19,50-20,00 zone, is the wrong time to extrapolate weakness.
The USDZAR an outlier relative to the commodities terms-of-trade From a more fundamental perspective, the rand also seems very weak relative to where South Africa’s commodities terms-of-trade suggest it should be. The rand remains a commodity currency and has tracked the country’s commodities terms-oftrade well over the years.
While there was a structural break in this relationship in March 2020 at the start of the pandemic, the relationship was re-established at a new level and continued thereafter. With the rand at 19,70, it is a clear outlier once again (Exhibit 4). While South Africaspecific events are clearly driving the currency weaker relative to where external factors, via the terms-of-trade suggest it should be, we remain cognisant that this has happened before, eg in 2015 when Finance Minister Nene was fired. Then, too, the relationship re-established itself after a while.
Source: Nedbank CIB Markets Research
Multivest Chartbook - May 2023
Source: Multivest Research
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Disclaimer: The investor is liable for CGT on any transactions in the units of the underlying unit trusts within the wrap funds. Compulsory investments are not subject to CGT. Performance is calculated using net returns(after fees) of the underlying unit trusts, and quoted excluding wrap fund fees. Performance quoted is pre-tax. Fund performance numbers shown are for a notional portfolio and do not reflect the actual performance of the client invested in the wrap fund due to timing differences of investments or disinvestments of the client. Benchmark returns for CPI are based on actual published returns and an estimated one month return for the month of the report date. ASISA Benchmark returns are the ASISA returns available as at the time of reporting.
Uncertainty reigns, idiosyncratic issues batter South Africa
The banking failures in mainly the US and uncertainty about raising the US government’s debt limit continued to ruffle markets in May. At the same time, decelerating world economic growth is in full flight, barring a few countries. High food inflation continues to haunt Europe, while China’s economy is going through a Q2 dip. In South Africa, idiosyncratic issues and policy measures are “co-operating” to plunge the economy into a very weak state.
In the US Treasury Secretary Janet Yellen informed the Congress “Treasury will have insufficient resources to satisfy the government’s obligations if Congress has not raised or suspended the debt limit by 5 June 2023.” The looming debt limit combined with already unfavourable economic and market conditions further weighed on especially emerging economies’ financial markets (throughout the month), as it contributed to risk aversion. Following the nearing debt limit, President Biden and House Speaker McCarthy reached an agreement by the end of May to suspend the debt limit to 31 December 2024, provided certain spending conditions are met. In the meantime, the Federal Reserve’s minutes indicated uncertainty on the future interest rate path as consumer price inflation (CPI) remains high in an environment of resilient economic growth, accompanied by banking failures. The Fed minutes stated: “… in light of the lagged effects of cumulative tightening in monetary policy and the potential effects on the economy of a further tightening in credit conditions, the extent to which additional increases in the target range may be appropriate after this meeting had become less certain.” In short, this means the Fed is now considering pausing despite sticky CPI, which means a peak had been reached or will soon be reached.
Euro area composite PMI decreased to 53.3 in May from 53.1 in April, suggesting lower economic growth in Q2 2023 due to among others a struggling consumer sector. Several governments reverted to controversial price controls on the retail prices of food, while other countries cut VAT-rates on food and other household goods. CPI in the European Union increased by 8.1% in April, while food inflation was 16.6%. Consequently, the European Central Bank is expected to continue with its aggressive rate hiking approach. In the UK the CPI rate remained sticky due to the energy price shock and high food prices. As such another 25-basis point interest rate hike instead of 50-basis points in June is likely. In this respect about 33% of variable rate mortgage will soon be refinanced at higher rates, denting disposable income and demand, which should contribute to lower CPI.
China’s economy is due for a struggle in Q2 2023 following a recovery in Q1 2023. Latest PMI’s show a continuation below 50 points. This may prompt another bout of policy easing via a stimulus or lower interest rates.
South Africa’s economy continued to be battered from various sides. Allegations by the US ambassador that South Africa is arming Russia in the war against the Ukraine, continued logistical incapacities, higher states of load-shedding, threats of a grid collapse and another 50-basis point increase in interest rates will prevent the economy from growing by even a very low 0.5%. Global risk aversion in combination with these challenges contributed to the rand weakening to almost R19.90/US$ - more than 20% weaker than a year ago. This depreciation again demonstrated that higher interest rates are ineffective to contain CPI via the exchange rate channel, if the depreciation is caused by political factors in a risk-off environment – as the latter’s risk outweighs the return from higher interest rates.
Multivest Economic Division
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