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The Fed remains hawkish

March 17, 2022by Nicholas Kabaso
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Local Market Commentary

  • A local report citing Millers Association of Zambia President Andrew Chintala suggests that Zambia will start importing wheat in two weeks to fill a shortfall. The imported grain is set to be used until the local harvest is ready in September. Note that Zambia grows wheat under irrigation in winter, with planting that starts around April to May.
  • In the FX market, the Zambian Kwacha remained on the front foot yesterday, continuing to pare some of the recent losses. However, the broader trend remains bearish, with the local currency down by nearly 6% on a year-to-date basis against the USD. This has made it the second-worst performing African currency tracked by Bloomberg. Only the Ghanaian Cedi has fared worst. Much of the Kwacha weakness has been due to liquidity challenges as demand for hard currency has outweighed limited supply.
  • The Fed hiked rates by 25bp at its March meeting, matching expectations and signalling the start of the first tightening cycle since 2018. The final vote was 8 – 1 in favour of the 25bp rate hike, with Fed member Bullard voting for a 50bp rate increase. The dot plot, meanwhile, shows that the Fed expects there to be six more rate hikes this year. This is in line with what the market has priced in and comes despite the growth risks that the economy faces now due to the conflict in Ukraine and soaring inflation.  
  • In terms of its balance sheet, the Fed noted that it would begin unwinding its $8.9trn worth of assets at a “coming meeting” without providing much more detail in that regard. It also provided new economic projections, with inflation expected to end this year at 4.3% now, well up from the prior forecasts. The estimate for economic growth for this year was lowered to 2.8% from 4%, while the expected unemployment rate was left unchanged.
  • The Fed has not been swayed by the mounting growth risks facing the US economy, sticking to its very hawkish stance, which will see a total of seven rate hikes this year as things currently stand. The hawkish Fed will keep providing the USD with support over the near term, but there are still risks that it could be forced to revise its policy stance once growth starts to slow.
  • Notwithstanding the more aggressive-than-expected guidance from the Fed, the USD is on the back foot following a sharp bounce back in equity markets and an improvement in overall risk appetite. The VIX has retreated sharply, and the result has been to bolster most of the majors against the USD, with the EUR trading back above 1.1000/USDr and the GBP scaling the 1.3100 mark. Furthermore, the bias across most currency markets is more bullish against the USD, with even commodity currencies and emerging markets performing well. The underlying interpretation remains one of reduced risk aversion, responsible central banking to stave off growth sapping inflation, and the underlying strength of economies to withstand the monetary tightening.

Rand and International FX Commentary

  • As anticipated, the biggest driver of overnight volatility was not the war in Ukraine but the decision of the Federal Reserve. The Fed lifted interest rates by 25bp for the first time since 2018 and signalled a further six hikes to come through 2022. This was far more aggressive than investors had anticipated, and the initial reaction was a negative one, in that it was clear that the Fed was prioritising inflation. However, the negative market reaction did not last long when investors concluded that the Fed would only signal such an aggressive stance if it felt that the economy was strong enough to absorb it. A snap-back rally was back on, and stocks performed impressively to help drive overall risk appetite higher.
  • Counter-intuitively, the ZAR staged an impressive rally and smashed through the 15.00 barrier overnight to trade down to 14.9200 at time of writing. It almost certainly seals the deal for more rate hikes domestically, with the SARB likely to be mindful of the volatility it would impose on the market if it fell behind the Fed’s tightening cycle. The SARB has done well to hike twice in a pre-emptive fashion, which stood the ZAR in good stead through the past three weeks.
  • It is also important to note that commodity prices may not collapse just yet, the Fed’s tightening cycle notwithstanding. Not only will investors extend their expectation of a robust economy that can withstand hikes through to commodity prices as demand remains strong, but the supply shocks out of Ukraine and Russia remain intact. On that front, the lockdowns in China may be more of a risk to commodity prices, at least until the war ends and production schedules resume.
  • The combination of the lagged effects of the colossal stimulus efforts through Covid, supply disruptions for key commodities due to the war, and ongoing demand may just be enough to keep SA’s terms of trade alive. This has been a key factor in the ZAR’s performance, and judging from the reaction overnight; it is not yet time to turn bearish on ZAR. The timing of that may materialise later this year when the dust settles and markets normalise, but for now, the ZAR continues to enjoy some tailwinds. It is good news for SA as it stabilises prices and eases the pressure on the SARB to act aggressively on monetary tightening.


Nicholas Kabaso

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