Local and global risks portend to a potentially volatile first quarter

Compiled for TreasuryONE by Lloyd Miller, Co-Head Financial Markets at ETM Analytics


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Risks to the ZAR have shifted in recent months, but this is not to say that the ZAR will find it easy going in the quarter ahead. Investors have to price in a range of factors, from the resumption of infections of the Omicron variant to the strength of the US economy and the implications for US monetary policy. It makes picking direction difficult, especially as there are several risks that could drive some volatility. Beyond this volatility, a recovering local economy and easing of commodity prices will leave the ZAR open to depreciation towards the latter half of the year. Any bouts of appreciation in the coming weeks, therefore, should be utilised to purchase USDs or forward cover.

Risk Factor: Tighter Global Monetary Policy

  • While growth concerns have resurfaced, it is clear that major central banks, including the Federal Reserve and the Bank of England are committed to tightening monetary policy. Although the global financial system is flush with cash at the moment, the tide has turned, and growth in global dollar liquidity has begun to decelerate as stimulus is gradually removed from the financial system. The upswing in the dollar liquidity cycle has now peaked and global dollar liquidity has begun to moderate. As the supply of dollars to the global financial system slows, there is less hot money to be diverted to riskier emerging and frontier market assets and they can experience volatility.
  • Inflation pressures remain robust as the new year kicks off. It has become clear that inflation is far stickier than many central bankers had anticipated as the combination of elevated commodity and food prices continue to buoy consumer prices the world over. Another major contributor has been the ongoing supply chain issues, which are not expected to ease until at least the second half of the year. That said, while we expect inflation pressures to remain elevated in the first half of 2022, we could see some moderation in the second half of the year given the high base effects and hopefully the return of normality to global supply chains.
  • The market currently expects the Fed to hike rates four times in 2022. Although we see this as overdone at the moment, higher rates will materialise with the first hike potentially in March.

Expectation: The Fed and other major central banks will be forced to hike rates this year. This is, however, mostly priced in by the markets already. Data releases or Fed speak supporting rate hikes may generate some near term volatility in the markets, but longer-term the risk is actually that we could see this degree of hawkishness scaled back, which would support riskier assets.

Probability of Rand influence in 6 – 9 months: 100%

Risk Factor: Budget Speech in Feb

  • Some key commitments were made in the medium-term budget in November. The finance minister committed to constraining expenditure, becoming sensitive towards permanent overheads, reducing support for dysfunctional SOEs and utilising any near-term windfalls to reduce the country’s overall debt burden.
  • The medium-term budget showed that the window of opportunity to implement reforms has opened a little wider thanks to a strong commodity cycle and the response of the mining sector rather than anything that the government has done right. How the government uses this fiscal space through the next fiscal year will determine whether SA can reclaim some lost ground or whether the deindustrialization that has characterised the past decade continues.

Expectation: Although the rhetoric used in the MTBPS was encouraging, investors will be looking for concrete evidence that the Finance Ministry is committed to pushing through much needed structural reforms aimed at boosting growth while at the same time steering the country towards a more sustainable debt path. Some of the key areas that will need to be addressed are the inflated public sector wage bill and the privatisation of SOEs, which for the most part, are a significant burden on the government. Some progress is likely, but the harder reforms that are so needed will not materialise. SA’s fiscal degradation will be slowed, but not reversed.

Probability of Rand influence in 6 – 9 months: 90%

Risk Factor: COVID-19 Pandemic

  • The Omicron variant has seen lower rates of hospitalisations and deaths than
    previous strains, even as infections have soared globally. This may usher in the end of the pandemic, with the lower virulence of the new strain allowing countries to eventually lower their restrictions and begin to live with the virus as an endemic disease, similar to the common flu virus.
  • This will allow the world to return to normality. Until then, however, rising cases in Europe, Asia, and the US will place strain on hospitals and keep many restrictions in place. The implementation of new restrictions is having a limited impact on the market, but the effects are being felt in global supply chains and in certain sectors such as tourism.

Expectation: Beyond the next few months, the world will start to live with the virus. This will be a positive for risk assets including the ZAR in general. However, it should be noted that as South Africa returns to normal, we will see consumption levels increase and the trade surplus deteriorates and eventually resort back to a deficit, which will erode a major pillar of stability that the local currency has enjoyed over the last two years or so.

Probability of Rand influence in 6 – 9 months: 80%

Risk factor: State Capture Report

  • The Zondo Commission’s first report was released to the public within a few hours of being released to the president earlier this month as a sign that ANC leadership is working towards a high degree of accountability. After a total cost of roughly R1bn for the enquiry, a total of three reports are expected to be released between now and the end of February. This process will be kicking up some political uncertainty given the implicated members of government, and the potential that prosecution leads to further evidence against the network of corruption that remains at nodes of power within the party.
  • President Ramaphosa now must follow through and ensure that the findings
    generate accountability that would justify the enormous expense of the exercise. This, of course, raises the risk that non-democratic political forces such as those mobilised during the July 2021 riots become active again.
  • Even if action is taken and those implicated are found guilty and punished accordingly, the impact that the years of malfeasance and inefficiency have had on the economy will take years to rectify. Social-based government spending will remain elevated relative to investment-based spending, leaving SA with a difficult and weak foundation from which to begin to grow again.

Expectation: Although the report’s findings are initially seen as positive, they will
have little impact if actions are not taken. A clear sign that corruption is being dealt with will be ZAR supportive, but there have been very few signs to suggest that what is needed to be done will be. Political risk will remain a headwind to the ZAR over the coming months. It may not directly weaken the currency, but will limit the extent to which it can gain amid a supportive external environment.

Probability of Rand influence in 6 – 9 months: 70%

Risk Factor: Geopolitical Tensions

  • A major factor to keep an eye on is what has been taking place on the border of Russia and Ukraine, where the risk of a Russian invasion is starting to rise. Russia is in talks with NATO and under threat of sanctions, given Russia’s action in Crimea in 2014. This has already disrupted the supply of goods and services to other parts of Europe, reflected in rising aluminium and nat gas prices. A Russia-Ukraine conflict will likely add to the bullish momentum in key commodities such as gas and oil – which SA imports – and some metals. It will also raise the chances that the West puts Russia under sanctions again that could hold negative economic consequences for both parties, the latter being one of SA’s largest agricultural sector customers.
  • North Korea, meanwhile, has fired two ballistic missiles this year already in a move aimed at increasing pressure on the US amid stalled nuclear talks and building economic problems for the regime. The show of force has not yet yielded any results and we could see testing and other activities amplified if no progress is made soon in achieving economic aid concessions. Given the ZAR’s high-beta nature, rising geopolitical risks will exacerbate any bouts of volatility for the currency.

Expectation: Although both the Russia-Ukraine and North Korea situations have the potential to escalate, diplomacy will most likely allow at least for a de-escalation. Tensions will remain high over the near term and will remain a factor to watch for market participants in early 2022. As noted above, this will leave the ZAR more vulnerable to bouts of volatility.

Probability of Rand influence in 6 – 9 months: 50%

Bottom Line:

From an international standpoint, risks facing the ZAR remain elevated even if these risks look a bit different to what they did in recent quarters. The world is moving away from the pandemic, and market focus has shifted towards what the global economy will look like going forward. This means monetary policy normalisation and combatting the imbalances that have been created as a result of the global lockdowns and the massive stimulus measures deployed. However, an initial sigh of relief may drive risk appetite as we exit the pandemic, allowing for some potential ZAR appreciation before the negative effects of global monetary policy normalisation are felt.

Locally, political and fiscal risks remain pertinent. There has been a lot of talk of implementing more sustainable policies and rooting out corruption, but so far, none of that has materialised in any significant manner. This will keep a risk discount embedded into the ZAR, with the potential for the currency to unwind some of this if we see progress made on these fronts. If we don’t, SA’s descent into the fiscal danger zone and its corruption-embedded government will continue to detract from the appeal of the currency.