Rand volatile until Fed tapering becomes clear
THE rand is on the back foot again. It has depreciated more than 40c against the dollar over the past week, after reaching a high of R9.56/$ before the policy meetings last week of the US Federal Reserve and the South African Reserve Bank. In the topsy-turvy world of quantitative easing (QE) and tapering it should have strengthened, all things being equal, as the Fed decided not to commence with tapering. Continuing QE by buying bonds of $85bn per month creates liquidity, thereby supporting emerging market currencies.
If QE is to be reversed, the rand would turn the other way and depreciate. Similar market rumours in the past that the Fed intends not to reduce QE led to an immediate appreciation of the rand. Why not this time?
One market view is that tapering has not been done away with.
It was simply postponed to another date, now expected to be either December or the first half of next year. That means the conditions for a weakening rand over time remain.
The stronger dollar could also partly explain rand weakness, but then it has not been overly strong, given fundamentals, as the US is facing another struggle in Congress over the debt ceiling, thereby theoretically supporting risk-taking in other currencies.
Another view is that the currency is actually testing the resolve of Reserve Bank governor Gill Marcus, after her much more hawkish utterances at the last monetary policy committee (MPC) meeting.
Has she the courage of her convictions to go ahead and hike rates, when the consensus is that the Bank is not in an advantageous position to do so against the background of job losses, rising debt and an election next year?
The MPC’s hawkish view comes at a time that the Indian central bank has hiked rates and other emerging market countries have implemented steps to support their currencies, notably in Brazil and Turkey. These measures have had minimal effect due to the extent of daily global currency trading.
According to the latest figures of the Bank of International Settlements, the daily average turnover in global foreign exchange markets amounts to a massive $5.3-trillion, up from $4-trillion in April 2010 and $3.3-trillion in April 2007. Large financial institutions dominate the activity, making it difficult for smaller traders, or even central banks, to influence the direction of a currency.
Foreign exchange trading is concentrated in large financial centres. The UK, US, Singapore and Japan represent 71% of the world’s foreign exchange trading, with the turnover in London more than twice the size of the entire US.
Foreign currency trading in the UK is larger than the currency markets in the US, Singapore, Japan, Hong Kong, Switzerland and France combined.
It is in this world that the rand must find its footing every day. Basically, the currency is at the mercy of foreign traders, although funda- mental economic factors in SA, such as physical exports and imports and real transactions, make it more difficult than in the past to push the currency into a desired direction.
Daily foreign exchange trading in Johannesburg amounts to $27bn. Although a huge amount compared to SA’s gross domestic product, it is at only 0.3% minuscule compared to the overall daily trading of $5.3-trillion. The dollar still remains the preferred trading currency, representing 87% of all foreign exchange trades. The euro is the second most-traded currency, but its share has fallen sharply to 33% from 39% in April 2010.
Although dollar/rand trading amount to only 1% of world currency trades, dollar/rand trades accounts for 85% of all SA’s foreign currency trading.
It would therefore be prescient for the Reserve Bank not to challenge the markets in a way that was done in the past. All past interventions by the Reserve Bank were futile, ranging from Chris Stals’ massive buying of dollars in 1998 and Tito Mboweni’s steps in 2001 to require traders to classify rand trades as legitimate or not to discourage speculative transactions.
Most of the daily transactions in rand in any case do not occur in Johannesburg. Total daily trading in rand amounts to $60bn, with less than half done in Johannesburg and the rest mostly from London.
A more prudent step for the Bank would probably be to increase currency trading with other emerging markets. The Mexican peso and Chinese renminbi are now among the 10 most-traded currencies. But actions to increase co-ordination at recent Brics and Group of 20 summits have achieved little.
This means rand trading will remain volatile over the next few months until greater clarity is reached on tapering.