Market News 28 August 2020

What we know

Another week, another roller-coaster! The Rand started Monday on the front foot and moved relentlessly stronger until Tuesday afternoon, gaining all the way from 17.16 to 16.72. While the initial move firmer was largely on the back of a weaker USD, sentiment in general was improved, allowing equity markets and emerging market currencies to extend their rally. Thursday saw a bit of chaos as Fed Chair Powell’s speech outlining a new approach to US monetary, saw markets struggle to interpret the implications. The USD-index initially weakened by 0.70%, before rebounding 1% within an hour. What this meant is that the Rand moved from 16.97 to 16.80, then back up to 17.05 a short while later. Having then touched 17.11 overnight, the ZAR has surged this morning (once again against the backdrop of a weak USD) to 16.69 at the time of writing.

 

Appetite for risk remains

Whatever the reason behind it may be – optimism regarding how the pandemic may play out, improved economic sentiment or whispers of China and US relations improving – the Rand continues to trade defiantly (together with other emerging currencies) and contrary to our fundamental view.

While we’re by no means suggesting that everyone does (or should) agree with our view, there does appear to be a disconnect between the general sentiment we are hearing and the performance of the Rand. The flood of global liquidity, the search for yield and a view that the Rand may be undervalued in terms of economic models, means that for now some traders and investors are willing to bear the higher risks associated with emerging currencies.

 

Making sense of the Fed

The knee-jerk reaction in the USD to Jerome Powell’s speech yesterday, and the subsequent spike in volatility over the past 24 hours, illustrates that the market is struggling to digest the implications of the Fed’s change in monetary policy. The debate itself largely becomes one of economic theory and debate around the merits of different levels on inflation and unemployment and, as such, there will be numerous conflicting views and responses to the change. For now, the main take-away remains that the Fed will continue to be very dovish and accommodative to enable the economy to continue its recovery, even if the result requires higher inflation and lower unemployment than would have previously been desirable.

 

Is Fundamentals vs Technicals

The main contrasting ZAR views in the market seem to depend on the time horizon one is considering, and whether short terms techincals, yields and balance of payments should trump economic fundamentals and structural risks. Those believing that the ZAR should be closer to 16.00 are typically looking at the shorter-term drivers and charts, while those (such as ourselves) who believe we should be trading at higher levels seem to be focused on the economic hole in which we find ourselves, as well as the risk of Rand blow-out given the current uncertain global environment.

At the moment it looks like the ZAR bulls continue to have the upper-hand. Looking at the chart below, we wouldn’t have expected the break below the blue descending wedge to happen, which does potentially mean there could be further strength in store.

 

What others say

24 August 2020

MoneyWeb – China risk may overshadow emerging markets eyeing vaccine hopes

“The final week of August may prove key for emerging markets attempting to erase this year’s losses as investors fret that rising US-China tension will overshadow optimism on vaccine developments.”

25 August 2020

Zero Hedge – The anatomy of a financial crisis (& why we should all worry about European banks)

“Recession leads to diminished income and defaults by both corporations and households. This increases the share of non-performing loans in bank loan portfolios, reducing the value of loan collateral and increasing bank risks and capital needs. As write-downs and losses increase, mistrust among other banks and depositors and investors does as well. The bank’s share price will usually start to reflect this.”

26 August 2020

Business Insider – A surge in SA inflation may have killed further interest rate cuts

“Consumer inflation spiked unexpectedly to 3.2% in July, Statistics South Africa announced on Wednesday. This is a massive 45% increase from 2.2% in June – and the biggest one-month rise since February 2016.”

27 August 2020

Business Maverick – Powell’s Fed shift allows for higher employment and inflation

“Calling the revised strategy “a robust updating,” Powell said that after periods when inflation has been running below 2%, monetary policy will likely aim to achieve inflation moderately above 2% for some time.

28 August 2020

Bloomberg– Fed’s new plan to lift inflation faces skepticism

“Chair Jerome Powell Thursday outlined a new approach to setting U.S. monetary policy. The Fed, he said, will sometimes allow inflation to run above the 2% target to make up for prior undershoots, and allow unemployment to run lower than officials had previously tolerated.”

 

What we think

 

Last week we wrote that “…too often we see individuals trading either with hindsight, hope or a combination of the two. While clients who moved funds offshore during July may have got a bargain (as things stand) we typically suggest to clients to not look back to what may have been. Rather assess your unique requirements in the current environment, consider what levels are acceptable to you and what risk you are willing to bear in terms of market volatility and potential weakness, and make an informed decision when regarding your transfer.”

These are not easy times and, while calling the Rand correctly is hard under normal circumstances, it is particularly challenging at present. We remain of the view that South Africa faces challenges that even the brightest minds and best intentions could take years to fix, and that any economic recovery will be slow. The cupboards are bare and structural reforms need to happen quickly.

In this context, even though short-term trading may favour the Rand and the possibility of a strengthening overshoot exists, we continue to believe that the potential pay-offs remain asymmetrical and that the potential risks that could lead to sell-off of, say 18.00 carry a higher probability than seeing a catalyst that could justify a move to 16.00.

We favour a return to the 16.90 – 17.30 in the coming weeks; however, our range for the week ahead is 16.55 – 16.90.

 

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Have a great weekend!