The rand has benefitted from dollar weakness in recent sessions as slower-than-expected US inflation data eased pressure on the Federal Reserve to aggressively raise interest rates.
While US inflation remains elevated, and well above the 2% target set by the Fed, the market was pleasantly surprised by a lower-than-expected annual rise in consumer prices during July, said financial services firm, Citadel.
The data released on Wednesday, showed a decline to 8.5% in July from the four-decade high of 9.1% in June, compared to the market expectation of 8.7%. The decline in inflation, was largely brought on by lower gasoline prices, which offset further increases in food and shelter.
While inflation remained flat month-on-month, core inflation was steady at 5.9%, beating expectations of 6.1%, and offering some support to the theory that US inflation has finally peaked, said Citadel.
True to the volatile nature of the recent trading environment, investors moved swiftly to reposition themselves for a less aggressive US Federal Reserve (Fed).
“Investors believe that that the Fed will now hike interest rates slower and by smaller increments, which sent risk appetite through the roof. Following the CPI release the dollar sank to its lowest level since June, declining by 1.1%. Now, while the market is certainly expressing its relief by piling into riskier assets, one should not make the mistake of thinking that our troubles on a global economic scale are over,” said Bianca Botes, director Citadel Global.
“If we are lucky, we are out of the woods, but we are still knee-deep in the rough, with risks and uncertainty in abundance,” said Botes, including:
- Inflation is still well above the 2% target, although the Fed will, in all likelihood, not be fully against an inflation rate of near the 4% mark, as this will assist the US in diminishing its debt burden in real terms.
- Geopolitical risks are still abundant. The war in Ukraine rages on, while tension between Taiwan and China remains elevated.
- Global debt remains at dangerously high levels, reaching a record $303 trillion in 2021, compared to $226 trillion in 2020.
“Another key factor that needs to be taken into consideration, is the fact that the US labour market remains robust, with the US seeing near full employment, even as the country enters a technical recession. These factors will make it slightly harder to reign in demand to counter inflation,” said Botes.
The South African rand benefitted from the subdued dollar and the risk rally and is appreciating sharply towards R16.20/$, its highest level since 28 June, and reaching a high of R16.11/$ during trade on Thursday, she said. The local currency however remains at the mercy of the broader global environment, and any shift in sentiment will see the rand tumble yet again, warned the currency expert.
- Dollar/Rand: R16.20 (0.21%)
- Pound/Rand: R19.72 (-0.14%)
- Euro/Rand: R 16.69 (0.19%)
Locally, South Africa’s SACCI business confidence index rose to 110.3 in July, up from 108.5 in the previous month. It was the highest reading since March, assisted by a rise in trade volumes and new vehicle sales. However, price pressures, a volatile rand exchange rate, and higher interest rates continue to weigh on the local business environment, said Citadel.
“The July 2022 BCI (business confidence index) number indicates the business climate is gradually returning to normality,” SACCI said.
Meanwhile, manufacturing production in South Africa declined by 3.5% year-on-year, after a downwardly revised 1.8% fall in the previous month, and a sharper decline than market forecasts of a 2.9%. The decline marks the third consecutive month of contraction in manufacturing activity, largely attributed to load shedding.
Bloomberg reported that the dollar’s best days might still be ahead of it.
While the greenback has tumbled as riskier assets have rebounded and demand for havens has ebbed, there’s potential for renewed political and economic risks to rekindle its strength. Add to that a dire outlook for Europe and prospects for even more policy tightening by the Federal Reserve, and there’s scope for the US currency to bounce back and eclipse the highs it reached in mid July, it said.
The Bloomberg dollar index, which measures the currency against a basket of major developed- and emerging-market peers, has dropped around 3.5% from the unprecedented high it reached on July 14. Its decline was turbocharged this week as softer-than-anticipated US inflation data took some of the air out of Fed rate-hike bets, dragging down front-end Treasury yields and boosting stocks.
But some observers, pointing to both growth and inflation risks, are doubtful that kind of dollar-negative situation can last.
“I am not convinced we are past peak recession fears,” said Bank of Montreal’s global head of currency strategy Greg Anderson. While he concedes that July might very well have been the top for the dollar if there aren’t further significant upheavals, “it’s very easy to see some type of a shock in the next three months that brings those fears back to the forefront and the dollar index back up to another high.”
A significant part of the recent decline has been the reassessment of expectations for the Fed in light of more moderate inflation numbers. Yet not everyone is convinced that the central bank will be able to temper its tightening path.
“Inflationary pressures are still quite firm,” said Bipan Rai, Canadian Imperial Bank of Commerce’s head of foreign-exchange strategy. “The Fed is still going to be hiking and the terminal rate is going to end up higher than what the market is pricing in,” he said. And that’s likely to help the dollar restrengthen.