JOHANNESBURG - D-day for the much-anticipated Fed interest rate decision finally arrived, but global markets seem to have been caught with their pants down.
While the interest rate cut of 25bps was already priced in, the subsequent testimony by the Federal Reserve Chair, Jerome Powell certainly wasn’t. Moments into Powell’s address, it became clear that the Fed was no longer as dovish as previously portrayed, and certainly not nearly as the dovish as the ECB which painted quite a dire picture only a week earlier.
Recent data from the US, including GDP, employment and wage numbers, indicated a resilient economy leading many to wonder whether the Fed was not acting prematurely. The less dovish stance by the Fed might not have been market friendly, and President Trump is certainly not thrilled by the renewed dollar strength, but one can argue that it is in fact the correct approach by the Fed given the above mentioned resilience. Consumer confidence in the EU remained flat at -6.6 in July, while industrial sentiment worsened to -7.4. Wednesday was quite a busy data day for the union, with GDP marginally decelerating to 1.1% year-on-year, while CPI also declined to 1.1% in July from the previous 1.3%. The unemployment rate remained flat at 7.5%. Manufacturing PMI, released on Thursday evoked little reaction, remaining flat at 46.5%. Retail sales and PPI are due for release today.
The pound sterling remains under pressure as the weight of Brexit and its ongoing uncertainty continue to rattle the market. Manufacturing PMI slightly exceeded market expectations, remaining flat at 48 points while the BOE kept interest rates unchanged at 0.75% on Thursday. Today sees the release of the construction PMI that is forecast at 46 points.
China and the US remain at odds with no trade deal in sight, while the slowdown has in recent months been reflected far more in Chinese economic indicators than US indicators. Chinese manufacturing PMI rose incrementally in July, reaching 49.7points, while non-manufacturing PMI undershot its target, declining to 53.7 points.
President Trump also sent ripples through the market overnight on Thursday, announcing that he will be imposing an additional 10% tariff on $300bn’s worth of Chinese goods, once again escalating the trade war between the two countries.
Global factors ruled the rand this week
Little attention has been paid to local events over the past week, with the release of the final report of the presidential advisory panel on land reform and agriculture on Sunday barely making its way to the financial market headlines.
The political landscape remains largely unchanged, while the Public Protector continues to suffer blows to her competency and credibility and calls for her removal grow louder. The commissions of inquiry into state capture and the PIC are ongoing and South Africa should probably brace itself for much more dirt to be aired before we can fully understand the extent of the state capture as well as identify all the various role players.
Anticipation of the Fed’s interest rate cut has been largely responsible for the recent strength witnessed in the currency, driving it to trade at overvalued levels for quite some time. This, however, came to a screeching halt on Wednesday evening, with the Fed making it clear that the 25bps drop is not the start of a rate-cutting cycle by the Fed, and action will only be taken as and when needed based on the economic data and activity.
The rand rapidly lost ground as the news made its way to market, losing 1% in the overnight session. The currency extended its losses on Thursday, making its way to the R14.50 mark. By Friday morning, it had swept through this key support level.
Underlying local fundamentals point to future rand weakness
The current picture for the local unit is not a pretty one, with many risks now coming to the fore as the shadow of the US interest rate cut vanishes, leaving the fundamentals bare for all to see. Some of the key risks weighing on the currency include:
Potential downgrade of SA credit ratings, following the negative remarks by rating agency Moody’s, and the change in outlook by Fitch from stable to negative;
- Unemployment is at the highest level in 11 years, at a depressing 29%;
- SARS will likely not collect its budgeted revenue this year, adding additional strain to the fiscus;
- Eskom remains a cash drain on the government, with no end in sight for its financial turmoil;
- Economic growth remains subdued, now estimated at a lowly 0.6% for 2019;
- Ongoing global geopolitical tension between the US, China and other key trade partners.
Local data had little effect on the rand during the week, with the local unit showing no response to the shocking employment figures released on Tuesday. The number of unemployed people in South Africa is now at 6.7m.
Rand slumps in wake of trade spat and hawkish Fed, outlook poor
The rand is expected to remain under pressure, given the rally in the dollar on the back of a less dovish Fed. With the Fed announcement out of the way, we will see local fundamentals as well as economic data become more relevant once again in the pricing of currencies, and the picture locally remains a dismal one.
Geopolitical factors will also once again make their way into the spotlight, and markets are sure to keep a close eye on President Trump’s Twitter account.
Some of the local data due for release next week includes the Standard bank PMI numbers for July as well as mining, gold and manufacturing production. China is up for a busy data week, with the focus falling on imports and exports, while the US is due to release numerous manufacturing data.
After punching through the R14.50/$ mark, the rand will now test the R14.80 level.
We start the day on the back foot at R14.65/$, R16.22/€ and R17.73/£.
Bianca Botes is a Treasury Partner at Peregrine Treasury Solutions.