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Sunday, March 7, 2010

Rand Prospects 2010-2012

By Cees Bruggemans, Chief Economist FNB
22 February 2010

The present US context would appear to warrant another year of Rand firming against the Dollar. Also, the European context warrants Rand firming against the Euro.

Yet not everything may support such outcomes.

The Rand’s advance against the Dollar ended five months ago. It is uncertain how far recent Euro weakness will proceed, boosting the Rand. Also recent domestic policy actions may eventually favour Rand moderation.

So what gives in 2010 and beyond?

Following the Great Crisis (2007-2008), the Great Recession (2008-2009) and resulting policy responses, 2010 could quite easily be a copycat repeat of 2009 for the Rand.

As the Rand firmed steadily in 2009 from near 10:$ to 7.50:$, a copycat repeat could yield further Rand firming towards 6:$ this year.

Asia should remain a growth locomotive, with China leading with 10% GDP growth. Most of the developed West will be a slow coach, starting the year with 10% unemployment and policy determined to keep rates low.

It is a context favouring firm commodity prices and capital flows into emerging equity and bond markets, also firming their currencies.

Yet the Rand reached 7.50$ by September 2009, thereafter coming to a standstill. This probably reflects many forces. US growth recovery was more robust than other Western countries, inviting Dollar revival. During 4Q2009 Europe encountered sovereign fiscal weakness, spilling over into Euro weakness and more Dollar safe haven strength in 1Q2010. Chinese policy tempering also fed global concerns.

All these dynamics guided risk aversion, limiting capital flows, causing emerging market pullbacks.

Throughout the Rand appeared in suspended animation at 7.20-7.80:$. These same forces could continue to prevail in coming months, keeping the Rand near 7.50:$ within a wide trading band.

Meanwhile the Anglo-Saxon banking troubles, having triggered the Great Recession, also uncovered many old fiscal sins in Europe’s monetary union. Late in 2009 and into 2010 this put downward pressure on the Euro, causing Rand firming towards 10:€ and potentially beyond it.

European monetary union wasn’t accompanied by political union. Every country retained fiscal sovereignty. The Financial Stability Pact of 1997 created an artificial straightjacket, requiring every country to limit its fiscal deficits to 3% of GDP. Reality was a lot more flexible and was papered over by the good times, with weak countries getting subsidy support from rich countries as well as their bonds being able to leverage handsomely off Germany’s good name.

When the Great Recession struck, it greatly worsened fiscal finances in Europe’s periphery, even suggesting eventual sovereign default, putting the focus fully on inadequate European coping mechanisms.

With some European countries suffering weakened finances and rich Europeans unwilling to bail them out, the Euro headed lower firming the Rand towards 10:€.

Yet Europe may not be in freefall.

Europe’s periphery (Greece, Portugal, Spain, Ireland) faces painful fiscal adjustment (higher taxes, public spending cuts) with increased unemployment. Even so, such fiscal weakness may ultimately require European support. Though rich taxpayers may balk, letting the monetary union unravel would be more costly.

Besides, resulting Euro weakness is good for exporters and fragile European recovery. This is worth something, warranting some European backing for its weak periphery.

Financial markets appear to be accepting the tough love meted out to the periphery, the superficial willingness to ‘stand’ by weaker countries, the retention of fiscal sovereignty, and the advantage of a weaker Euro.

America’s financial crisis may have weakened the Dollar as its interest rates fell to near zero, favouring US exporters and supporting US growth. It all went at Euro expense to which Europeans had no answer, until Greek fiscal trouble started to force the Euro lower.

Though European fiscal strain could be substantial in coming years, with the European centre unwilling to support its periphery unduly and fiscal sovereignty mostly surviving, markets do recognize the benefits of Euro weakness, thereby probably arresting it.

Thus Rand firming against the Euro could also moderate eventually.

In coming months US growth could keep favouring the Dollar, eventually further bolstered by Fed rate tightening later in 2011-2012 even if US fiscal fundamentals longer term indicate Dollar weakness.

Despite our small balance of payments funding needs and global positioning suggesting rich commodity export prices and large capital inflows, the Rand could yet remain in suspended animation near 7-8:$ and may eventually give way to renewed weakness above 8:$ from 2011-12.

Domestically, flexible inflation targeting (hinting at keeping rates cyclically low in 2010-2011) and exchange control reform (giving banks greater ability to support client activity abroad) also hint at Rand moderation.

Thus the latest Rand firming cycle against the Dollar may surprisingly already have ended in 2009, and its belated firming against the Euro in early 2010 may be contained ere long. Eventually new cyclical easing may materialise.

The high water mark for Rand overvaluation could be near 7:$ and 10:€. Beyond 2010 looms eventual US and European policy normalization and their currency revival, potentially implying less Rand strength towards 8:$ and 11:€, actively abetted by our own policy actions.

Cees Bruggemans is Chief Economist of First National Bank. Register for his free e-mail articles on

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