Short Note 13 December 2016
The changing risk scenario
by Cees Bruggemans words 720
Things are rapidly changing, event driven. Our main SA risks are global capital flows and domestic politics affecting private confidence and responses. Both of these may have turned more positive, but the global more so than the domestic, much of it counterintuitive.
There was the pre-Trump, Clinton-inspired view of the world in which the Fed could remain slow acting, with our capital flow remaining supported by carry-trade yield search. The Trump election changed all that, but serially, and possibly in unexpected ways. The domestic outlook appears fluid, with the Zuma era losing dynamism, yet the outcome not as yet firmly nailed and as such uncertain.
The Trump election unleashed much defensive caution. In our case, the fear that Trump fiscal activism would get a robust response from the Fed, and that accelerated rate hikes, and bond yield increases, would negatively impact our capital flows as the carry trade died and search-for-yield refocused on overseas asset markets.
Traditionally this is posed as the “sudden stop” scenario.
The result would be a much weaker Rand, higher inflation prospects and possibly a vigilant SARB still raising interest rates.
As the days and weeks went by, however, the post-election Trump era started generating surprises. Certainly there was the buy-in to more fiscal action, higher US growth and higher inflation, with their 10yr bond yield in four weeks rising by 0.75% from 1.74% to 2.5% (the equivalent of three Fed rate hikes BEFORE the Fed even had time to move). But alongside this fearful bond repricing, there was also a joyous equity market repricing, reaching for record levels.
Some people sensed to be on wrong side of history, others on the right side. This deepened with every passing day.
The Fed kept signaling it would raise by 0.25% in December but took its time saying it would not pre-empt any Trump fiscal & trade plans. Instead, the Fed will react to data as it materialises. Though no given, this still suggests a slow Fed trajectory for the time being.
Throughout this post-election Trump era, so far only one month old, the Rand kept getting stronger, reaching 13.50:$ rather than encountering a sudden stop in capital flows. That had a lot to do with ongoing globally benign environment as other EM currencies also remained supported. Why?
It could be that Trump is awakening global animal spirits. Talk remains of increased policy uncertainty, and select companies (defence) are being singled out for public criticism, but that isn't what broader markets are reflecting. There is a strong growth-expectant surge in the way markets are repricing, and could keep repricing in coming months.
Could it be that awakening animal spirits (increased market and business confidence) could be generally global-positive? That is one outcome that has not been discounted. And yet here we are, a month after the Trump election, and a lot of markers remain positive.
There is also the sense that domestically our August SA local elections and the rating agencies holding back on an downgrade in December were Rand positive. Add into this mix a sense that President Zuma is losing influence in shaping things. It feeds expectations of an imminent change in political direction, in 2017 and in 2019.
It may be that such thoughts remain fanciful, and that the global context remains paramount, for all emerging markets in shaping their currencies.
But one is allowed to believe?
This adds up to a potentially better global outlook for the Rand, even if the Fed has to increase its hiking pace. Instead of debilitating Fed risk, are we getting supportive Trump risk via equity markets and rising business confidence?
Domestically, the past 12 months seem to have changed the political outlook positively, but it has yet to be confirmed in new leadership and policy stance. Both may still disappoint in coming years, or simply not be enough to transform our domestic economic prospect as much as some hope.
Summarizing, domestically we remain a going concern with upside potential (despite rating agencies warnings) while globally the positive expectational forces unleashed by the Trump presidency may be stronger than allowed, with even we gaining crumbs from that table.
It is not a dismal outlook. It may even become a pleasing prospect. Its main barometer will be the Rand. So far, so good.
Bruggemans & Associates, Consulting Economists