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Rand Outlook
From FNB - Dr. Cees Bruggemans
14 September 2006
With the benefit of hindsight, early 2005 saw the Dollar's low (1.38:?) and the Rand 's high (5.60:$).
Thereafter, a rollercoaster set a new course. Instead of new highs, the Rand encountered two new cyclical lows near 7:$ in mid-2005 and 7.50:$ only two months ago. Cyclical pullbacks only got the Rand back towards 6:$ in early 2006.
The Dollar/Euro had a reverse experience.
So what happened, and where to from here?
What happened globally was that the US had started to tighten interest rates gradually from mid-2004. Within six months this change basically provided a safety net for the Dollar, preventing further sliding.
Since then, US short-term interest rates have risen by 4.25%, the Dollar has moved sideways with a firmer bias, and emerging markets re-encountered risk intolerance.
Many emerging markets acquired strong external surpluses, either because they were successful industrial stories ( China ), or were favoured commodity stories ( Russia ) or had experienced slow domestic growth while benefiting from the commodity boom ( Brazil ). Their currencies successfully withstood global testing.
South Africa 's profile was quite different. Strong domestic growth and imports, poor export-oriented policies and limited exploitation of the commodity boom substantially boosted its external deficit to 6% of GDP.
That was unacceptable once US interest rates reached critical levels and global interrogation of riskier emerging countries hit in 2006, marking the Rand down.
The two keys going forward are global developments and the evolution of our external deficit.
Even if household consumption growth after three years of averaging 6%-7% moderates towards 4-5% and eases imports, fixed investment acceleration should see renewed import surging. We are stuck with a high external deficit for some years. This should weigh on the Rand .
That leaves the global cycle.
Limited US growth slowdown and lingering inflation pressure would keep global interest rates moving sideways with an upward bias. This would be Dollar supportive and precious metal unfriendly. It would probably also heighten intolerance towards the Rand , moving it deeper into 7-8:$ territory.
However, more people see pronounced US growth slowing, inflation giving way, and the Fed erring on the downside by cutting rates. That would be Dollar-unfriendly, supportive of precious metals and improve tolerance towards the Rand at 6.50-7.50:$.
Two types of extreme scenarios lurk in the wings. A wild unraveling of global imbalances, dumping the Dollar and massively boosting precious metals, could again favour the Rand extraordinarily.
But global events pushing oil prices much higher may have elements of all these scenarios with unpredictable outcomes, though decline in US growth, interest rates and Dollar could favour precious metals and the Rand.
During the global cycle of the past five years the Dollar first declined heavily and then topped out. During this same period, the Rand first firmed dramatically for three years (from 13.85:$ to 5.60:$) and has since jerkily eased towards 7.50:$ for two years.
But once this global cycle terminates, and we roll over into the next global cycle, do we find the Rand having peaked (in 7.50-8.50:$ territory), and thereafter during 2007-2010 entering a new firming cycle?
Favouring medium-term Rand firming would be renewed US rate easing, easing Dollar and precious metal support, potentially encouraging capital flows our way. But a moderating influence (unlike during 2002-2005) would be our sizeable external deficit (4%-7% of GDP, depending on how much GDP growth and importing is sustained, and how exports and commodity prices fare).
The Rand may face a narrow risk cone of 7-8:$ within a wider risk band of 6.50-8.50:$. This would be mostly a continuation of 2003-2006, but with an evolving set of drivers. Outsized movements would require special events.
Original articles published at www.fnb.co.za.
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