Rand breaks ranks with euro
There’s some curious development in the currency markets
THERE’S NO DENYING the effect of the rand on financial markets. The 20% weakening in the US dollar/rand exchange rate since May 2006 accounts for much of the lift in resources and rand hedge stocks, which make up a hefty weighting on the Alsi 40 index.
Predicting the future trajectory of the rand is a fruitless exercise, since the chances of getting it wrong are so high. However, Ken Humphries, CEO of VFP Exchange, a currency treasury and software house, says there’s some curious development in the currency markets. Those keeping an eye on currency developments would do well to take note.
The first is an inverse correlation between the rand and the yen: the rand weakens as the yen strengthens, and vice versa. The second is that the US dollar has taken on the colour of an emerging market currency, as the euro and yen are now perceived as safe haven currencies.
“One would hardly see a natural correlation between the rand and the yen. Unlike the Canadian dollar and the yen, which have a link through oil – Canada being a major producer and Japan being a major consumer – there’s no direct linkage between the yen and the rand,” says Humphries.
“However, the market has changed mood with developments in the Middle East turning sour and the expected weakening of the US economy following the housing slump. Japan is finally showing an appetite for increased interest rates and that’s led to a phenomenon called ‘flight to safety’.”
Humphries says there are growing fears of an economic downturn in the US due to expected failures in the sub-prime housing market. That, coupled with nervousness in stock markets worldwide, has prompted
investors to unwind emerging market positions and run for cover in the stable yen.
“The past few weeks have witnessed a new form of volatility to which we should become accustomed – and quickly. Correlation between the euro – the currency of our biggest trading partner – and the rand has all but disappeared and the euro has steadily strengthened against the rand. Weakness in the greenback now signals weakness in the rand.”
In times past the rand weakened against both the euro and the US dollar, but that trend’s now broken. It’s weakening against the euro and yen and strengthening against the US dollar.
That could have a profound effect on future economic developments for SA, adds Humphries. “With the infrastructure spend necessary to keep SA viable and internationally competitive the rand’s going to come under increasing pressure.
The failure of the SA grain crop this year due to drought suggests we may have to import two to three million tons of maize. That – at an average price of R1 780/t – will require foreign currency of upwards of US$6m on its own.”
So while technical analysis indicators show some strength to the rand, the fundamentals suggest a currency that will continue to weaken at a fairly even pace. That’s not all bad news. Economists are suggesting that GDP growth in the Gauteng area will be far in excess of historical norms over the next decade.
That will not be an isolated affair and other major centres in SA will also benefit. To finance that and retain an acceptable trade deficit will require a major increase in exports, for which a weaker rand is imperative.
That should keep the JSE and company earnings afloat, at the same time allowing SA to finance a heavily listing trade deficit.
Ultimately, currency rates are determined by interest rate differentials between countries, though that’s an imperfect measure prone to contamination by a host of other factors, such as political stability and geopolitical tensions.
A scenario largely discounted by economists is that a strong domestic economy could actually strengthen the rand. The country may be inversely correlated to the rand, but it’s also inversely correlated to the gold price.
Talk of a higher gold price, perhaps as high as $800/oz, is no longer confined to conspiracy theorists (some considering $5 000/oz an achievable target). If that happens the rand will surely head back towards US$1/R6 and euro/R8,50.