/ 12 October 2015

Boosted rand has an unclear future

Emerging markets have been pummelled in recent weeks on the back of fears that the US Federal Reserve could begin reining in its extremely loose monetary policy
Emerging markets have been pummelled in recent weeks on the back of fears that the US Federal Reserve could begin reining in its extremely loose monetary policy

The rand rallied last week, along with other emerging market currencies, but the reasons underlying the boost are at best temporary.

Last week the rand, alongside other emerging market currencies, rose sharply in large part due to data reinforcing market expectations that the United States may not hike interest rates until early 2016, according to FNB economist Alex Smith. 

But he warned while this offers a short-term reprieve, in the medium term the pause on a US rate hike raised more concerns for emerging markets than it settled. 

Emerging market currencies last week had their best performance since 2009, according to Smith.

The rally coincided with relatively disappointing economic data out of the United States revealing that US non-farm jobs are growing at a slower pace than hoped.

This has reinforced expectations that the Fed will hold off on a hike this year. 

Last week, the US Federal Reserve also released the minutes from its September meeting. At that meeting it had opted to put off the interest rate increase, following months of speculation that it would finally begin returning to more normalised monetary policy. 

The minutes revealed that although US policy makers believed economic conditions in the world’s largest economy were improving moderately, the risk to this outlook had increased.

The minutes stated that: “Members noted that recent global and financial market developments might restrain economic activity somewhat as a result of the higher level of the dollar and possible effects of slower economic growth in China and in a number of emerging market and commodity producing economies.”

“Underneath it all [this] reflects the fact that the US is very worried about the global economy,” said Smith.

In many cases, emerging markets were grappling with difficulties that structural rather than cyclical he added.

In the case of South Africa, the economic outlook remains gloomy.  Last Tuesday the International Monetary Fund reduced the South Africa’s economic growth forecast for 2015 and 2016 from 2% and 2.1% to 1.4% and 1.3% respectively 

The IMF flagged electricity shortages and infrastructure bottlenecks in the power sector, as well as the need to implement structural reforms to education, labour, as well as product markets, in order to to raise competitiveness and productivity.

Emerging markets were under a lot of pressure and China was of particular concern to the United States, Smith said, adding that it also happened to be a key economy that South Africa trades with. 

The decision not to raise rates indicated that the world is not resilient enough to withstand an interest rate hike by the US, said Smith

There was, however, no guarantee that by early next year the picture would have improved by much. 

“I am not sure, even if the Fed does hike in January, that emerging markets are going to be in a better position to handle that hike,” he said. 

“And then we are going to be in a position where emerging market growth is slowing because of factors unrelated to the US and then you could have [a US rate hike] exacerbating the problems.”