R22.50 to the dollar by 2018?

A leading economist has painted a bleak picture for the local currency, the rand, against a surging US dollar.

Cees Bruggemans, consultant economist at Bruggemans & Associates noted in a blog on his website that the rising dollar reached, on trade-weighted basis, a 20-yr low four years ago, but took three years to rise 6%, and has risen by an additional 15% so far in 2015.

He said that the crisis in Greece, a crash in the Shanghai stock market in China, ‘and especially the Fed (Federal Reserve Bank) steadily progressing with bond tapering (2014), followed by mounting anticipation about Fed interest rate liftoff (2015)’ has given the dollar turbo power.

He said that a Fed liftoff, in late 2015, along with a delay by the European Central Bank (ECB) and Bank of Japan – 2016-2017 – is such a powerful combination as a game changer in global capital flows. “America will become yield-favoured as its short-term rates rise,” Bruggemans said.

“It will not mean the end of global yield-seeking, but it will create a powerful attraction besides higher yielding riskier asset destinations. America will be getting back into the game even as Europe and Japan – large net savers and foreign investors both – linger in zero-rate territory.”

The economist forecast that capital is going to favour America where for long this wasn’t the case. “It means a stronger dollar still, and by implication weaker currencies elsewhere,” he said.

What does it mean for the rand?

“If you want to know where the rand will be traveling the next three years, take our underlying inflation differential – about 4%, roughly – and add a dollar appreciation factor and a rand depreciation factor – do I dare call it SA IDIOsyncracies?”

“And what rand decline rate do you get?” the economist asked.

“Not zero – rand appreciating in real terms. Not -4% annually – rand holding its own with dollar in real terms, but more likely something in -6% to -10% territory,” Bruggemans said.

At best (-6% annually), he said that suggests a rand of 13.25 against the dollar in mid-2016, 14 in mid-2017 and 15 in mid-2018. It would mean a rand depreciation of 20% over three years and a further real rand depreciation of 6% by mid-2018.

At worst (-10% annually), it suggests 13.75 against the dollar by mid-2016, 14.50 by mid-2017 and 16 by mid-2018 – for a rand depreciation of 30% over three years and a further real rand depreciation of 14% compared to today’s currency.

“Still, having travelled from seven to the dollar in 2010 to 12.50 today – nearly 80% in less than four years – these numbers aren’t particular intimidating, given what we know of a dollar on steroids,”  Bruggemans said.

He questioned whether he was underestimating the damage that the dollar could do, “and would we, in believing that, be underestimating the American and global recuperation powers from recent crises?”

“Previous cycles saw outsized dollar rises. This one will be no different, only more gradual, is the betting, given the global fundamentals and central banks behaving.

“It still suggests a manageable Rand mangling over three years, but less so than what happened in the past four years. Is that for real?

“Or are we looking at another 80% down by mid-2018 – rand at 22.50 to the dollar?”

He pointed out that the rand was still super-cycle overvalued in 2011 when the most recent re-rating began. The real trade-weighted rand has since gone through a long overdue adjustment, becoming undervalued in the process.

That creates a shock buffer, as do our already wide bond spreads, Bruggemans said.

“Still, the world may not be finished re-rating us, even if it isn’t in shock mode. The coming Fed liftoff will ensure another shift in relative yield attractiveness and that will affect capital flows and currency values. The rand included. It has further depreciation to go as the Dollar has the cyclical advantage.”

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