GLOBAL ECONOMY: Tug-of-war between euro and US dollar will dominate
The rand has so far shrugged
off euro weakness
A YEAR AGO there were expectations that interest rates in the United States would rise in 2010. The London Financial Times reported in an early piece comparing the situation to 1994 and warning that markets could be caught by surprise by a tightening US Federal Reserve, which was a hopelessly optimistic view of the path of recovery taken in the US. Hit by continued fallout from the housing crisis and a stubbornly high unemployment rate, the Fed eventually decided on further monetary policy in November last year through quantitative easing.
In the Eurozone, forecasts were also horribly wrong. Nobody foresaw the sovereign debt crisis that led to big bailouts for Greece and Ireland and continued concern about Spain, Portugal and Italy. These worries overshadowed a pleasing performance by Germany.
In emerging markets, the opposite was the case: people didn’t expect the strong growth from those regions that occurred. In fact, so strong has growth been that some of these economies are now in danger of overheating.
South Africa, itself an emerging market, wasn’t so lucky. At the start of the year it looked as if a growth rate of 3,5% could easily be reached, which seemed to be confirmed by a first quarter growth rate of 4,6%. However, the rest of the year was a disappointment, with growth only reaching 2,8% in the second quarter and 2,6% in the third (All figures are seasonally adjusted, quarter-on-quarter growth rates, unless otherwise stated). The SA Reserve Bank hadn’t been expected to cut interest rates at all last year. In fact, some economists expected an increase. Instead, the repo rate was cut three times by a total of 1,5 percentage points.
What lies ahead? Will the economic recovery in the US gain traction? Will the Eurozone debt crisis again roil the markets? How will SA fare? In the US there have been forecasts of higher growth, given the extension of the Bush tax cuts and other fiscal measures. The Bush tax cuts applied to the rich and President Barack Obama agreed to extend them when they expired, despite opposition from within his own party. Obama hopes the extension of the tax cuts will provide fiscal stimulus to the US economy. At the same time tax cuts to poorer households were also extended, with the same aim.
Some analysts argue the withdrawal of the US$800bn stimulus spending will be a drag on its economy. But the tax cuts and other fiscal measures largely take care of the problem. In fact, these tax cuts raise the fear that the US fiscal deficit will become unmanageable. At 8,9% of gross domestic product over the past fiscal year, the US fiscal deficit looks dangerously European in its scope. However, the painful adjustments have been postponed and, over the short term, US growth is likely to pick up.
This view is further supported by the Fed’s quantitative easing: the pumping of hundreds of billions of dollars into the US banking system through the Fed’s buying of government bonds. Bank of America expects the Fed to extend its bond buying programme and buy a total of $1 trillion of US treasuries.
The pumping of money into the US banking system has a depressing effect on the greenback. That’s why China can argue the US is also a currency manipulator. The Chinese, of course, are the world’s champion currency manipulators with an overly weak renminbi.
However, the depressing effect on the US dollar is offset by the turmoil in the euro area. The Eurozone sovereign debt crisis has a depreciating effect on the euro. Both the US dollar and euro can’t depreciate at the same time. There will be a tug-of-war to see which currency weakens.
So far, the rand has been buoyed by the Walmart takeover of Massmart and has shrugged off the euro’s weakness. But rand strength is unlikely to lead to further interest rate cuts this year, unless it really sprints ahead. Meanwhile, SA’s growth rate is likely to have been slightly below 3% last year and could improve to slightly above in 2011.