By Cees Bruggemans, Chief Economist of FNB. South Africa professes much protective policy action aimed at containing the Rand’s strength. There are the SARB’s ongoing purchases of foreign reserves ($0.5bn monthly budgeted, these reserves likely climbing to $50bn by end-2011). The SARB is using forward swaps to neutralize incoming corporate deals (there could still be many such deals, for many of our corporate assets still look desirous). There is the exchange control relaxation (improving Rand two-way trade) and possible increased overseas diversification by public pension funds. Yet despite these many protective intentions, the Rand may remain primarily influenced by global events. That’s not to say that our own protective measures will fail. Merely that other forces may prove bigger while we still have a small current account deficit and dividend outflows requiring only modest foreign funding (always relatively judged). If all that is so, where is the Rand heading – still towards 6:$ (and 8:€) or 8-10:$ (and 12:€)? And when?—————— I am inclined to Rand strength for the time being, for as long as US policy activism and European brinkmanship are evident. Going by appearances, this could be a while. Those deep winds alone could grease the Rand’s ascent. If we then also still face a precious metal boom, sourcing its strength in these selfsame global ponds, the Rand acquires yet more backing. Never losing track of China and its regional brood as their catch-up growth fuels global commodity demand and prices, offering us yet more fuel for Rand firmness. In other words, the Rand’s recovery story of 2009-2010 may not be over, and could continue in 2011-2012. The entire movement can be seen as a cyclical upswing phase reminiscent of the 2002-2006 Rand firming episode.——————– US growth is clocking 2%-2.5% while unemployment jumped to 9.8% last week, never forgetting the additional 7% of the US labour force identified as underemployed or discouraged (no longer even trying). In total 25.5 million people as compared to more normal frictional strain of 8-10 million on a 150 million labour force. Despite a bit of US retail firmness, and some more growth firming in 2011, US unemployment is unlikely to dip much during 2010-2012, with underemployment and discouragement also remaining elevated and historically challenging. This alone will prevent a lift in US inflation, with core likely to underperform the Fed’s 2% wish for years still. None of this suggests a US policy exit soon, yet US fiscal policy is now firmly exiting, courtesy of some truly convoluted politics according to which political party wishes have preference over the national interest. That leaves Fed monetary policy the only barrier between gradual US recovery and structural recasting as compared to backsliding and deepening despair. For the Fed to continue its supportive role, it probably can’t be passive. In order to be supportive, the Fed may need to keep moving (if you wish nervously dancing around the ring, in imitation of Mohamed Ali decades ago, jabbing air and occasionally crunching bone). The Fed already lowered interest rates to zero nearly three years ago. As a supplement, it bought $1.7 trill of bonds (QE1) two years. Last month it embarked on a second programme of buying Treasury bonds held privately (QE2), at a rate of $75bn monthly, plus reinvesting repaid debt proceeds of $35bn monthly. The aim here is to reduce the stock of such bonds in private institutional hands, inviting investors to use the cash to buy other things (equities for instance). This determined bidding up of asset prices assists in overcoming private scruples, creating wealth effects via various household, business and foreign channels, thus inciting more spending, boosting US and global growth. For as long as the Fed is so engaged, it would have an expansionary supportive influence over asset markets and the global economy, a firm backstop to backsliding. One set of arguments say the Fed will continue doing this beyond its mid-2011 target date, eventually buying over $1 trill through 2012 instead of the $600bn announced. Others are saying that both slightly better US growth data and political aversion and pressure to desist may influence the Fed to limit this intervention to mid-2011. Bear in mind 2012 will see Presidential elections and another Congressional upheaval, and Bernanke’s [[first]] term as Fed chairman will end shortly thereafter. Not a reason to go for broke [[yet]], but one wonders about the nuanced calculations here, everything over there being politics and then some. It is probably premature at this stage to suggest the Fed will hold back beyond mid-2011. US performance will likely remain too slow for very long, and lingering labour despair will be VERY important in the 2012 election cycle. It may be fatal for the Fed to be seen doing “the wrong things” but it may be politically catastrophic to be doing nothing. My sense is that come mid-2011, the Fed won’t desist, but will carry on implementing its mandate DESPITE any incoming political torpedoes, as the economic and financial case for ongoing policy support will simply remain too compelling (let me add, to American eyes). If so, that will be one massive engine making for more Dollar weakness against all currencies that can rise because they have their domestic debt and growth stories under control and their protectionist shields only partially deployed (including South Africa).—————— Whereas only very recently Europe was seen as the PRIME candidate for seeing its free-floating Euro strengthen further against the Dollar as these US policy stances play out, this looks increasingly no longer the case. For Europe’s internal problems are like a poison pill, probably not taken with any overt calculation in mind, but merely the accidental consequence of many political actions and choices. Europe has a sovereign debt problem, and hidden behind it in deep background apparently an even greater banking problem. Encompassing it all is a yet greater political problem as political elites procrastinate or pursue wildly disruptive agendas, still focused on European integration. The ECB, as chief financial conductor of this wayward continental orchestra, has turned prematurely grey, trying to forcefully talk European governments into taking more reform action WITHOUT instantly sinking the ship underneath its feet (an apparent German inclination) and similarly coaching capital markets to come along for the long ride WITHOUT these also at any stage rebelling and sinking the ship. And doing all THAT without become bailer or jailer of last resort and burdening his balance sheet with bankrupted sovereigns and banks. Those headaches are for governments and markets to sort out, even if the ECB likes to watch how they fare, and give a helping hand where this is sensible WITHOUT becoming engulfed by either party. Quite a dancing master, our Trichet, as ever charmingly French as opposed to the German gruffness on display. One wonders HOW the ECB will cope post-2011 with the challenging public eye, once Trichet retires, unless the equally charming Italian dancing master Draghi gets the nod instead. A space worth watching.—————– Europe is a crisis in progress as it tries to institute important changes to its governing rules of the game (unvarnished Germanic discipline for governments and their market creditors) without having morose investors detonating funding markets by walking away. So far, Greece and Ireland had to be taken out of the line, no longer privately funded for the next four years as Europe carries them (at a price). But financial markets keep signaling their unease with these arrangements, sniffing out new victims to give the beauty treatment, encouraging Europe to buy out yet more of its members in the short term (and storing up how much problems in the medium term?). Portugal is next. Beyond her looms Spain. And beyond her loom Italy and Belgium (and even France and Britain). This isn’t over yet. Further bedeviling the whole thing is that beyond these sovereigns having non-sustainable features there loom still many European core banks having heavily feasted on such peripheral sovereigns and associated private [[bank]] debt. To the order of a couple of trill (three at least). That makes a few private bank balance sheets still highly doubtful. No wonder Trichet is everywhere. With so many walking wounded in his flock, our good shepherd needs to give the impression of firmness to circling predators while giving succour where it is needed most to prevent anyone giving prematurely the ghost and having the predators move in for the kill. Meanwhile he is urging governments at every turn to do more to address these many weaknesses while there is time. They certainly are making him earn his pension, but he seems to love his job, like Bernanke, so see this all as positive. Not least because both these gentlemen are deeply convinced their arguments are right and will win out. And also not least because they have VERY deep pockets (the deepest, for they can print money without end, if the notion takes them, understood by all).——————– So how will the Europeans square their circle? Probably very, very slowly. Do expect episodic market attacks on weak stragglers, after which evasive ECB action creates time for governments to take some more defensive action, giving some respite, until the next round (still thinking Ali). In the process, the Euro can be expected to go through bouts of weakness (during market introspection and attacks) and partial revivals (when the ECB wastes a bit of its precious ammo to keep the predators hopping). But instead of the Euro steadily gaining on the Dollar as it is consciously made to slide QE2 assisted, Europe’s internal problems may well regularly trump America’s. As hedge fund fundy Fink opinioned two weeks ago, this could well make for the Euro revisiting 1.20$/€ (from over 1.30 now).——————– For the Rand these are intimidating storylines playing out. With American (and European) actions feeding global anxieties we could see our precious metal prices still boosted episodically. And this is in addition to naturally weaker Dollar and Euro tendencies. These are powerful engines against which we should see our own protectionist efforts for what they are worth. On balance, a yet firmer Rand seems likely, though not as a straightline proposition. Instead, with many ups and downs, regular feints as our policy defences are tested (and the Americans, Europeans and Chinese each in turn encounter their own hiccups) markets are like to continue to churn on their wild camel-ride. For now I would expect Rand firmness and further firming. And it could still last quite a while.
updated Dec 08, 2010
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