The rand continues to demonstrate its close relationship to international events, exhibiting a high degree of volatility this year on the fluctuation in global risk-aversion levels.
It has been the third-most volatile currency in its grouping on the switch from the “risk-on” environment in the first quarter of this year (purchase of risky, or emerging market assets), to “risk-off” in the second quarter.
This switch was driven by the flare-up in the euro zone’s sovereign debt crisis in April, centred on Spain’s need for a banking sector bailout, and market fears that the sovereign itself will need a bailout if its borrowing costs maintain unsustainable levels (10-year bond above 7 percent).
The rand has a daily turnover of $15 billion (R126bn) at the latest estimate, and this depth and liquidity makes it one of the key emerging markets targets for speculative activity. Indeed, when the Reserve Bank announced in October 2001 that it would enforce exchange controls more strictly in a bid to curb speculation, a large amount of liquidity was drained from the markets as foreign players withdrew.
This resulted in very thin, volatile trade, with the rand reacting severely to any form of local bad news, reaching R12.75 a dollar in December 2001. It only recovered when the policy was removed, and the “speculative” component returned.
The euro area is awaiting the return of its officials from their summer break and the ruling of German courts on the advent of the European Stability Mechanism, Europe’s permanent bailout fund.
The increasing likelihood of another round of quantitative easing in the US has potentially greater implications for the rand. Quantitative easing saw substantial rand and other emerging markets currencies’ strengthen, from R10.20 in 2009 to R6.60 in 2010, as the resultant liquidity sought yield in the emerging markets. US policymakers are hinting that another round of quantitative easing is on the cards as the unemployment rate is still high, only marginally off recession highs.
The latest Federal Open Market Committee (FOMC) minutes state “that economic activity decelerated somewhat over the first half of this year”. “Growth in employment has been slow in recent months, and the unemployment rate remains elevated.”
Additionally, “the housing sector remains depressed”. “Inflation has declined since earlier this year, mainly reflecting lower prices of crude oil and gasoline, and longer-term inflation expectations have remained stable and household spending has been rising at a somewhat slower pace than earlier in the year.”
The latest available figures show US growth slowing from 4.1 percent quarter on quarter in the fourth quarter of last year, to 2 percent quarter on quarter in the first quarter of this year, implying that the second quarter experienced further slowing.
Consumer confidence has recovered from recessionary lows, but is still well below the levels experienced before 2008.
Many Americans still experience financial distress in what is an election year.
The FOMC says it “seeks to foster maximum employment and price stability”. “The committee expects economic growth to remain moderate over the coming quarters and then to pick up very gradually.
“Consequently, the committee anticipates that the unemployment rate will decline only slowly toward levels that it judges to be consistent with its dual mandate. Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook.”
This dovish outlook is compounded by the commitment that it “will closely monitor incoming information on economic and financial developments and will provide additional accommodation as needed to promote a stronger economic recovery and sustained improvement in labour market conditions in a context of price stability.”
Many have taken this to mean that a third round of quantitative easing is in the offing, given also that “the committee anticipates that inflation over the medium term will run at, or below, the rate that it judges most consistent with its dual mandate”.
Quantitative easing occurs when new money is created electronically (to purchase government bonds), thereby increasing money supply.
The aim is to stimulate economic activity, increasing the prices of financial assets and so lowering long-term interest rates, to encourage borrowing.
Given that growth in US retail sales have slowed markedly since the start of the year, household expenditure growth has similarly come off, and growth in personal incomes has moderated, the case for more quantitative easing seems to be rising.
The Institute for Supply Management index has also dropped below 50 points, indicating supply-side activity is contracting, and growth in industrial production is at risk. The US economy is experiencing economic growth well below its potential, and as such, another round of quantitative easing, and consequent significant rand strength seem likely, possibly as early as the next FOMC meeting on September 13.
While there now seems to be a strong argument for more quantitative easing, the FOMC also acknowledges that “fixed investment has continued to advance”.
Additionally, data shows non-farm payrolls are climbing, as are corporate earnings and capacity utilisation continues to rise. However, these improvements are not consistent throughout the economy.
Anecdotal evidence also points to a slowdown in corporate earnings in the US that is yet to be reflected by the performance of equities. Another round of quantitative easing in September may be pre-emptive, but the October FOMC rate decision meeting may well be deemed too close to the presidential election of November 6, and monetary easing at the December meeting perceived as supportive of the elected.
The rand may have to wait until next year for its quantitative easing-driven strength, if it occurs at all; although 2013 brings its own set of challenges in the form of the fiscal cliff, automatic government spending cuts and tax increases totalling more than $500bn, which would cause US gross domestic product growth to contract by 4 percent in the first half of next year.
Clearly the annual meeting of the central banking fraternity at Jackson Hole this week will bring clarity.
Annabel Bishop is Investec’s group economist.