Developing world’s currencies fight back
Uncertainty over US interest-rate hikes dim dollar prospects
EMERGING-market currencies are on the rebound from the pain inflicted by a stronger dollar, low commodity prices and slower Chinese growth in the past year.
Whereas the US dollar a year ago provided the sweet spot for investors, uncertainty over aggressive interest-rate hikes in the world’s largest economy are dimming dollar prospects and again deflecting interest towards the currencies of emerging markets.
“Going into 2016, commentators were betting at least every second month that there could be a rate increase in the US of 25 basis points, but that seems unlikely now. I think most of the US dollar strength has taken place. Most of the fall in commodities has taken place,” said Tony Cadle, fund manager at Ashburton Investments.
Among buoyant emergingmarket currencies, South Africa’s rand has strengthened nearly 10% against the dollar since mid-January. Brazil’s real has appreciated just more than 12% despite clouds of weaker economic growth, political instability, ratings downgrades and recession.
A sell-off on Tuesday of riskier emerging-market stocks was brief following the terrorist bomb attacks in Brussels. The rand shed as much as 1% against the dollar on the day as investors opted for safe-haven assets.
Last year, the dollar strengthened by almost 30% against most emerging-market currencies as the Federal Reserve — the US monetary policy custodian — shed its quantitative easing strategy and indicated intentions to raise interest rates amid perceptions of a stronger US economy.
At the time, the Chinese infrastructure-led economy was rapidly slowing and demand for commodities waned. There was an oversupply of commodities. For export-driven, commodity-revenue-dependent emergingmarket economies — many saddled with large current-account deficits — this was disastrous.
The Fed continued raising hopes of US interest rate hikes, enticing investors to the dollar. When they were eventually raised in December, it was slight and higher rates seemed uncertain.
However, investors may be taking a different view to the dollar now.
The million-dollar question now was what level oil would rebound to and what level iron ore and copper would rebound to, and how much dollar strength we would have.
If the US economy continued to strengthen and the rate hikes materialised, the dollar would remain strong and commodity prices could hit new lows, said Cadle.
But if US economic growth is slower than anticipated and the hikes are postponed, there could be a partial rebound of the dollar strength at levels seen last year.
Emerging-market economies are still largely expected to be weak. Commodity prices will, in general terms, remain at low levels.
Even with Brazil and Russia in recession, emerging markets collectively are expected to grow by 4.5% this year, more than double the rate of 2.2% expected for developed markets, according to the IMF.
Capital inflows into emerging markets — although they are thought to be temporary — are heading back into emerging markets, particularly into bonds that are attractive.
Cadle said the yield on South Africa’s 10-year R186 bond was around 9.3%, significantly higher than the 0.3% yield in Germany, and even better than re- turns in the US and Europe.
But Ricardo da Camara, financial market economist at ETM Analytics, said South Africa faced a challenge of stagflation — where inflation remains high or rising, while growth is low or weakening.
“This tends to have a flattening on the [bond] yield curve shape.”
In the bond market this meant that shorter-dated bonds such as the R203 tended to underperform longer-dated bonds such as the R186 or R209, Da Camara said.
In Brazil, bonds are giving superior double-digit returns. “If you have the view that most of the dollar strength has occurred, then your currency risk is largely eliminated,” Cadle said.
The rand touched its weakest — R16.87 to the dollar — in January, but forecasts earlier this year that it could plunge as much as R20 to the dollar by the end of this year are not supported.
Cadle said that unless a dramatic event such as a ratings downgrade or negative political fallout were to happen, the rand could remain within the R16 to the dollar range at the most.
“As a house we have a R16 average for the year. We think a lot of potential ratings downgrade and the politics is in the price.”
The devaluation of the rand peaked in December last year when Nhlanhla Nene was fired as finance minister and replaced briefly with David van Rooyen.
Four days later, following a market uproar, President Jacob Zuma returned Pravin Gordhan to the position.
Aggressive monetary policy tightening in South Africa to rein in inflation, which spiked to 7% during February from 6.2%, according to data published this week, is expected to continue. The steady hiking cycle since January 2014 has this week pushed real interest rates into positive territory, which may be attractive for investors.
The Reserve Bank is expected to raise the benchmark repo rate by a further 50 basis points this year, depending on the rate of inflation that filters through the system later, according to Cadle.
John Ashbourne, Africa economist at Capital Economics, expected an interest rate hike of another 25 basis points in May’s monetary policy committee meeting.
A key forward-looking Reserve Bank indicator published this week showed that prospects for economic growth this year remained muted.
The indicator dropped 4% compared to a year ago following a 3.8% year-on-year contraction in December.
But Ashbourne said: “Further rate hikes will be painful, but we doubt that the South African Reserve Bank, which is explicitly tasked with controlling inflation, will risk its position as one of the few state institutions that is still trusted by investors.”
I think most of the US dollar strength has taken place. Most of the fall in commodities has taken place