Rand breaks ranks with euro

There’s some curious de­vel­op­ment in the cur­rency mar­kets

Finweek English Edition - - Asset management -

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.

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