Bottom Line:

• Although the noise surrounding the President’s Phala Phala debacle and the calls for him to step down are deafening, it is far from clear that the ANC will be dictated to by virtue signalling opposition parties looking for any excuse to pressurise the ANC into more self-destructive behaviour. In fact, the opposition party stance may even galvanise the ANC’s caucus to stand up against the perceived threat to their governance and show who remains in power.
• If one accepts that Ramaphosa will be asked to stay on and not resign, then the focus needs to shift back to underlying fundamentals to assess what the implications for the ZAR might be. To do so, the focus needs to shift to the behaviour of the central banks, including the SARB, to establish whether the Fed’s pivot, could indeed result in a phase of USD selling.

 

Assuming that the dust settles around Ramaphosa’s Phala Phala debacle and he is asked by the ANC to remain in his position, then the focus will turn to central bank dynamics and on that front, the USD looks set to lose a lot of ground through 2023, to allow the ZAR to stage a material recovery.

Ramaphosa’s Phala Phala debacle

Although this article was to reflect on the SARB’s decision to hike rates by a further 75bp last week and the potential implications of the decision, it would be remiss of us not to comment on the President’s political crisis regarding the sale of Buffalo at his Phala Phala game lodge. Suffice it to say that the ANC can ill-afford to lose another important figurehead due to internal factional battles that destroy the ANC’s perception as a party in control. Who would replace Ramaphosa is also a debate that has investors perplexed. The candidates currently available are equally, if not more, tainted by corruption scandals. Would it really make sense to replace Ramaphosa with these compromised alternatives?

Anything is possible, and the result will determine how the ZAR trades ahead of the ANC’s elective conference. Why is there so much dismay surrounding the possibility of Ramaphosa leaving the leadership of South Africa? The answer is clear: massive apprehension at the possibility that there is no one within the ANC leadership is remotely capable of taking over the role with any degree of comparable success.

For all that he has been criticised for tardiness in undertaking structural reforms, Ramaphosa nonetheless has been recognised as being at the forefront of attempts at bringing about such change. There is concern that any other possible leader identified to take over from him is ill-disposed to supporting such reforms. The one leader that stands out currently is the nominee from the majority of ANC branches to take over as deputy president, viz. Paul Mashatile. However, the latter lacks any business or trade union experience of the ilk of Ramaphosa, who has been a politician nearly all his adult life.

If it is not Mashatile, concerns are that Deputy President David Mabuza might take over the country’s presidency. He has been associated with corrupt and criminal activities in the past. The final obvious candidate to take over from Ramaphosa is Zweli Mkhize, who received the second-highest number of nominations from branches to take over the presidency of the ANC. However, he is also tainted with corruption relating to the theft of money earmarked for dealing with COVID-19.
In sum, no one within the ANC has the stature or experience Ramaphosa has within the ANC to keep running the country.

What also complicates the situation is that a change in the country’s presidency can only be affected by a recall of Parliament to take such a decision. It is still being determined whether the ANC would vote in sufficient numbers to ensure that Ramaphosa vacates his position. On the contrary, based on the overwhelming support he received from the branches’ nominations exercise, one suspects that the majority of members of the ANC will want to see him remain in his position, in line with the apparent preference of financial markets.

 

SARB keeps pace with Fed… sort of

Following the SARB’s rate decision last week, it is worth taking stock of where SA’s rates stack up against those of the US. Although the SARB started hiking pre-emptively, the Fed’s big bang approach meant that since the start of the hikes, the spread between the US and SA has narrowed slightly.

However, the SARB has unashamedly sought to protect the spread between SA and the US to discourage negative speculation against the ZAR. The only option available to the SARB is the lifting of interest rates, and in moving in lockstep with the Fed, they have preserved a spread over US rates. Albeit that the spread has narrowed to the tightest levels since 2006.

Although the spread could narrow a little further in the current mature tightening phase, there is a lot priced in already. Furthermore, the SARB is unlikely to allow the spread to narrow too far, given how vulnerable it would leave it. So, much will depend on what happens at the Fed’s December meeting. Should the Fed continue hiking, the SARB might well follow, but it is important to note that the factors that might drive further tightening are moderating.

 

Inflation topping out and reversing

Inflation rates in both countries appear to have peaked. Early forecasts show that inflation is likely to trend lower from current levels and moderate steadily throughout 2023. If anything, the rate of oderation may surprise investors, given that the rate hikes implemented are being augmented by quantitative tightening or the shrinking of central bank balance sheets. And many more central banks are shrinking their balance sheets beyond just the Federal Reserve.

It implies that growth will slow and that the credit cycle will moderate rapidly. The degree of tightening at both a monetary and fiscal level will ensure that the monetary space allowing inflation to manifest is being aggressively squeezed.

Along with moderation in inflation will also come a change in rate expectations. As things stand, the professional market is pricing in rate cuts as early as Q3 2023. If the Fed is going to lead central banks in cutting rates once more, the chances are much higher that the USD will lose some ground throughout the year.

Rate cuts the new theme for 2023

Judging by the implied market expectations of the Fed funds rate currently reflected by the Fed funds futures, investors are anticipating rate cuts in Q3 2023. This is the market front running a reversal in the inflation and growth cycle and positioning for a Fed that will gradually turn more supportive of the economy.

After that, the rate cuts are expected to continue throughout most of 2024. In a world where the USD is extremely overvalued and so much of that is a function of monetary policy disparity, the sharp reversal in monetary policy disparity will play an important role in assisting the USD in depreciating.

Typically, conservative monetary and fiscal policies tend to be more supportive of an underlying currency. This anticipated shift in monetary policy expectations will accomplish the opposite.

Furthermore, some of the economic data is now starting to reflect varying degrees of distress. At some point, the Fed will prioritise growth.

USD valuation has only just started to unwind

The backdrop to this is that the USD is extremely overvalued and vulnerable to a sell-off. The latest run of the valuation model places the USD more than 20% overvalued. For context, this is the highest valuation in nearly 40 years and is extreme. Historically such degrees of overvaluation have not been sustained for very long as they set in motion a range of market responses that result in a reversal.

Interestingly, this has more to do with the degree of USD overvaluation rather than debating whether or not the USD deserves to be overvalued. The USD could comfortably depreciate 10-15% and still be overvalued. In other words, one could still hold the view that the USD should be overvalued vs other developed economy currencies and still anticipate a bout of USD depreciation.

USD depreciation of 10-15% is substantial and would go a long way to assisting the ZAR stage a recovery vs the USD through 2023. That in itself would change the prospect for inflation which might assist the SARB in tilting towards looser monetary policy in a bid to help support GDP growth.

ZAR Sentiment Indicator strongest in years

Gathering corroborating evidence of a possible phase of ZAR strength is therefore important. ETM’s ZAR Sentiment Indicator rose this week to the highest levels in over two years, suggesting that a robust phase of ZAR appreciation vs the USD will follow.

The implied ZAR levels generated from this indicator place the USD-ZAR comfortably back below 15.00/dlr. From an inflation perspective, this would make a massive difference in reducing price pressures, directly through fuel prices and indirectly through parity pricing pressures in agricultural commodities.

Recall that the ZSI reflects a quantitative assessment of the degree of hedging demand of the ZAR vs the USD. The lower the demand for hedging, the more the professional market positions itself for a phase of ZAR strength. This correlates with the expectation of USD weakness and the reversal of US monetary policy. The SARB, for its part, has played the role of keeping policy conservative enough to support the ZAR in staging a recovery and reducing the room for negative speculation against the ZAR.