USDZAR hits 16.20!

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USDZAR hits 16.20!

Published Date: 2020-09-17 | Source: INCE|Community | Author: Gary Booysen

USDZAR hits 16.20!

Should you double down on rand or switch to US dollars?

It's been quite a week for the local currency. We've moved from above R17.00/$ last week all the way down to R16.25/$ at the time of writing.

To put the 4.4% move in context: This is more than you'll be paid for holding ZAR cash in a high-yield money market account for a year. But is this strength an opportunity to deploy your increased buying power, or should you hang on for a break below R15.50/$?

Well, as almost any market professional will tell you, trying to forecast short-term currency movement is a fool's errand. The FX markets are one of the largest, most liquid (and decentralised) markets on the planet. Price discovery is excellent. At the same time, the rand is also a popular proxy for international speculators to play the emerging market versus developed market theme. As such, moves are erratic, volatility is high, and all predictions should be taken with a pinch of salt.

But just because it's tough to predict, doesn't mean it isn't worth exploring. The nature of financial markets requires us all to make crucial decisions with limited amounts of information. Expectations set prices. And it's worth looking at where the biggest players in the market have set their expectations.

Getting a sense of where the big banks, brokers and leading economists have their 1-year FX rate expectation is a useful guide as to what is expensive and what is cheap when it comes to currency. These are the mega-brains which guide institutional FX decision making. Of the 27 contributors polled, we can see the current median estimate is R16.50/$. This makes sense, because when you have a highly liquid, generally efficient market, the central price expectation should set a peg around which the currency fluctuates.

The next step is to see where the high and low estimates are set. Currently, Investec is the most bullish of the local and international banks with their expectation set at around R15.55/$ 12-months out. On the other hand, Swedbank AB is the most pessimistic with a 12-month target set at R20.05/$. That is one serious range.

But just having a range is useful. If the most bullish bank is set at R15.55/$ you're probably not going to go too wrong buying dollars between R15.55/$ and R16.00/$. If we get there.

But what else should you look out for in FX markets this week?

Any currency pair is made up of two parts. In this case the ZAR and the USD. Each part is highly influenced by its respective central bank. This week we have both the South African Reserve Bank and the US Federal Reserve speaking.

Last night the Federal Open Market Committee (FOMC) delivered its findings. US policy makers are now predicting no move higher on US rates until at least the end of 2023. The Fed also expanded on its average inflation targeting framework, saying it will "aim to achieve inflation moderately above 2% for some time so that inflation averages 2% over time and longer-term inflation expectations remain well anchored at 2%". That is a very dovish statement.

On the local front, we'll hear from SARB governor Lesetja Kganyago today. And while the Fed seems set on remaining as dovish as possible (one of the reasons for the weaker USD) the SARB instead seems resolute on remaining hawkish.

Firstly, the governor has an incredibly tough job. Given local political shenanigans, I can only imagine there is immense pressure to prove the institutional strength of the SARB. The international community is no doubt watching. In my opinion, we've seen far more responsible policy coming from the SARB that we have from the Fed.

Secondly, the SARB is aware that using monetary policy tools to influence and mitigate the damage created by a virus and subsequent lockdowns is limited. You can drop interest rates and provide temporary relief to the indebted, but you're also penalising savers. And in the long-run, economists tell us savings should equal investment. And South Africa is in dire need of investment. Lower rates will not solve structural issues.

Finally, the ultra-accommodative monetary policy we're seeing out of the US is creating a bit of a headache for our local central bankers. On the one hand you would assume it gives us the room to cut rates further and become more dovish. But the flip side of the argument is that US rates are zero-bound. This means as we cut interest rates deeper in SA, the differential between SA and the US rates narrow. This creates an issue for the local currency.

When US rates were at 1% and SA rates were at 7.5%, you might be inclined to hold ZAR because you're receiving decent compensation for the risk of an FX depreciation. When the currency is at R16.20, US rates are at 0% and the money market is giving you under 3.5% suddenly the compensation for the risk of holding ZAR is far more pronounced. The decision to switch to USD is far simpler.

Yet, with all this uncertainty, the SARB will still need to make a decision this afternoon. Of the 25 analysts and economists polled by Reuters, 10 believe there will be a 25bps cut while 15 believe interest rates will remain unchanged. That is a very uncertain outcome by historical standards. If you look at the FRA's (forward rate agreement curve) it seems a 25bps cut is partially in the price. That means no cut tomorrow would strengthen the ZAR further. But if the bank cuts rates, you may see some weakening.

Looking at the big bank bets, Absa Capital, HSBC and Nedbank are predicting a cut, while in the "no change" camp we have Goldman Sachs, FNB and Investec. Currently, the top ranked contributor over time is Citigroup who is predicting a 0.25% cut. One thing we can say for certain is nobody thinks rates are going up.

So how should you play this?

As with almost all investment decisions, how you play this depends on who you are and how your portfolio is constructed. If you're a retiree, locked into fixed-income and money market products, you're probably going to grind your teeth at the thought of another cut. Jay Powell's "lower for longer" rhetoric probably means you're avoiding even "thinking about thinking about" your investments. The good news is that even in a lower rate environment there are plenty of medium-risk options available to you. You can generate internationalised returns, linked to global equity markets while still achieving partial or total capital protection. If this sounds like the solution to your low interest rate problems, you should probably enquire about our Structured Products.

Next, if you're sitting on an after-tax lump sum, you might do well with a direct offshore USD-based investment. Regulation 28 already limits your international exposure within retirement products, and since living in South Africa means many of your primary assets will be linked to the success of failure of the ZAR, correctly diversifying into offshore markets makes perfect sense. Buy those USDs while you can!

If you need help exploring offshore markets, our Advisory Stockbroking desk will take you through the best way to externalise your funds using the R1m and R10 million allowances. But they're also not going to leave you guessing in the offshore market. This desk offers end-to-end solutions which will take your local cash balance (earning next to nothing) into a fully invested and structured international nest egg.

Finally, if you're looking for local bargains, the JSE listed equity space is trading at massive historical discounts. And even when local exchange rates weaken or inflation picks up, listed equity positions can provide you with, not only a ZAR and inflation hedge, but serious upside as asset prices re-rate. If you'd like advice around your portfolio, feel free to email us on info@randswiss.com.