IN THE MARKETS: Worst could be over for rand, even if tapering starts

ANALYSTS and traders are still scratching their heads over the heady movement in the rand exchange rate on Friday.

Though still tentative, it did strengthen measurably on better economic data from the US, which was surprising, as earlier many positions had been taken for a weaker currency on such data. It was believed better data would allow the US Federal Reserve an earlier start with tapering, removing the easy money liquidity created by its loose monetary policy of quantitative easing (QE), which has caused much money to find its way to emerging markets such as South Africa.

Before the data were released, the rand traded at R10.45/$. It afterwards briefly spiked to R10.58, before ending the day at R10.31/$.

Barclays Research analyst Mike Keenan says it could have been that the rand bears saw the opportunity to take profits at these levels. It was evident that short selling predominated earlier in the week, with a view probably taken that the currency was oversold at about R10.50/$.

Rand Merchant Bank analyst John Cairns says the bounce-back was strong and sustained. Risks still remain but the threat of a run on the rand has been reduced meaningfully, not least because tapering may now be priced in.

There is now even more evidence that foreign investments are arriving to rebuild sold-off positions. After six weeks of continuous selling, there have been two days of good bond buying, which has been strengthening the rand. “It is early days, but maybe Friday’s payrolls number has brought an end to the tapering fears and therefore an end to the exodus of investments, pressure on the rand and threat of rate hikes,” he notes.

The optimistic view is growing. For example, Barclays Research, which is a noted rand bear, have pencilled in an average of R10.50/$ for March next year when tapering is expected to start in earnest. Although Barclays believes the rand could depreciate to R10.70/$ over the short term or even to the dreaded R11/$, it indicates that at R10.50/$ the rand has reached its upper floor.

What is interesting is that the rand is recovering or stabilising without any intervention by the monetary or fiscal authorities. This is in stark contrast with other emerging markets, where Brazil, for example, has aggressively hiked rates in order to stem any currency weakness and so support the real.

As Brian Kantor has shown in a recent research report for Investec, these actions have been futile and to no avail. They have also probably weakened the growth outlook for the Brazilian economy, creating a situation which the South African authorities have up to now avoided.

Reserve Bank deputy governors Lesetja Kganyago and Daniel Mminele have both emphasised the rand is a free-floating currency and will find its real value through trading transactions in the market. That is even though the Reserve Bank has taken a quite hawkish view since the middle of last year, indicating that the next move in rates will be upwards.

The relative rand strength has paradoxically reduced the need to hike rates to support the currency, which in any case would probably have been counterproductive, as Brazil’s experience showed.

Mr Kantor says the Reserve Bank has hopefully taken note that higher interest rates do not necessarily protect a currency. They almost certainly restrain domestic spending, thereby curtailing growth more than the higher short-term interest bonus created to drive capital flows.

With South Africa’s growth precariously low as it is, higher interest rates could have real deleterious effects. Should the focus not be on reducing rates then?

Some economists, notably Annabel Bishop of Investec, believe that is the way to go as the rand is not expected to depreciate much in response, as higher growth would boost inflows.

The Reserve Bank is not prepared to take the risk of lowering yet, preferring to keep the monetary ship on an even keel and steady for probably at least the next year or so.

However, if tapering is set to become less of a threat because of the rand stabilising, the clamour will surely grow that the Reserve Bank must take growth into consideration in its monetary stance, just as it introduced the flexible policy to accommodate higher inflation in the 3%-6% target levels.