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Local Market Commentary
- After recording its best annual performance since 2005 last year on the back of improved FX reserve levels, buoyant copper prices, and optimism over the August election victory of Hakainde Hichilema, the ZMW has come under notable selling pressure at the start of 2022. The ZMW has not only underperformed its South African peers but is currently the worst performing African currency against the USD, among those tracked by Bloomberg. According to Bloomberg data, the local unit has extended a sell-off that started last year and is currently trading at a more-than 5-month low, just shy of the 19.000 mark. Note, since December 9, the ZMW has lost around 17.00%.
- Much of the ZMW weakness can be attributed to tight FX liquidity conditions. Demand for hard currency from importers and the corporate on the back of improving economic activity has outpaced available supply and thus weighed on the local unit. With these persisting factors, the ZMW is set to weaken further this week.
- It is worth noting that the ZMW rally was in part driven by sentiment and that economic fundamentals remain the same at present. This, therefore, suggests that the current level of undervaluation of the ZMW on a real effective exchange rate basis is justified. Looking ahead, the bullish copper outlook notwithstanding, further room for appreciation will likely depend on the new government making significant headway in implementing the required economic reforms and addressing the existing structural challenges.
- Moving over to the U.S., yesterday, St Louis Fed President Bullard reiterated his view that rates should rise faster following four consecutive, strong, monthly inflation reports. Bullard was concerned about the impact on inflation expectations and that inflation dynamics were becoming a little more entrenched. He felt that the Fed needed to “ratify” market expectations of monetary tightening to preserve its credibility as an inflation-fighting central bank.
- However, while Bullard might be convinced that more aggressive tightening is the way to go, the rest of the FOMC board is far from convinced. Investors are also not convinced that the Fed will go so far as to hike a more aggressive 50bp in March. Behaving in this way could prove counterproductive if financial markets sell off aggressively and promote heightened levels of volatility. Such an event would detract from risk appetite as well as business and household confidence, not to mention how a reduction in balance sheet values could even generate negative feedback through the credit cycle.
- Although the USD does appear to be on the front foot, it has retreated slightly off its best levels. It continues to trade as a safe haven currency, and while the geopolitical tensions in Ukraine remain elevated, the USD will not be sold off aggressively. It is, however, important to note that the USD did not surge any further following comments from St Louis Fed President Bullard, implying that a lot of the tighter monetary policy in the U.S., if not all of it, is now priced in. Any reduction in geopolitical dynamics could eventually result in a significant correction in the USD.
Rand and International FX Commentary
- Tensions in Ukraine are running high, risk assets are experiencing volatility, the USD appears to be a little more bid, yet the ZAR appreciates against the USD. The ZAR’s remarkable performance reflects a much higher degree of resilience than most market participants thought possible. Given the ZAR’s status as a more volatile emerging market currency, heightened levels of risk aversion reflected in the VIX are precisely the kind of catalyst that would ordinarily drive the ZAR substantially weaker.
- Yet this morning, the debate revolves around whether the ZAR might be able to sustain a break below the 15.00 handle. There is an unlikely mix of inflation disparities between SA and many of its developed economy trading partners, shifting in SA’s favour, high commodity prices fueling a trade and current account surplus, and high carry attractiveness lending the ZAR support.
- Concerning commodity prices, the gold price has surged to the highest levels since June 2021 due to heightened geopolitical risk in Ukraine and the risk it poses to global financial markets. Gold retains its status as a hedge against inflation and financial market volatility. However, even the CRB industrial metals index improved considerably in recent weeks, despite having retreated off its recent highs.
- Then there is also the possibility that funds may be making their way to SA because the investible universe of EM currencies has shrunk courtesy of the troubles in Turkey and Russia. By comparison, SA’s relatively stable political and policy backdrop coupled with comparatively high bond yields has encouraged foreign exposure. Of course, much of this depends on the commodity cycle and how long that might run. The biggest threat is improvements in logistical supply chains and tighter global monetary policies. However, while the dynamics are currently ZAR supportive, a break of 15.00 is possible.