During the week we saw the Rand hit its lowest level against the Dollar in four years and for South Africans the tendency is to think “woe is me“, for clearly weakness is South Africa specific and we are once again being targeted by faceless currency speculators.
There is some truth to those comments, but where we as South Africans miss the boat, is that current rand weakness is not South Africa specific, but rather a function of the flight of capital out of Emerging markets and back to Developed markets.
The trigger for this move was the weakness of US treasuries, in which we saw bond yields move up to 2.92% during the week, led by a combination of September tapering fears and stronger than expected global growth numbers. Given that global bonds are priced off the US treasury market, weakness in that markets leads to weakness in all bond markets and EM bonds were no exception. As liquidity dries up, EM currencies are particularly vulnerable, especially those with large funding requirements.
As we have said above the Rand did not weaken in isolation this week, but did so along with another emerging market currencies, namely the Indian Rupee and the Indonesian Rupee. What we do have in common with these other emerging markets is that we are all running current account deficits and this makes us an easy target when global speculators want to short EM currencies . Given our propensity to spend more than we make, our current account deficit has started to widen in the last couple of months and with global capital less inclined to support the EM growth story, our currency has to weaken to attract foreign capital.
The FT featured an interesting piece on the EM story this week, highlighting that it has become a tale of two EM baskets, those with current account deficits and those with surpluses. The graph above shows, there has been a clear distinction in performance between the two in the current year.
In the short term, weakness in EM deficit country currencies appears to be overdone and with central banks in these countries having spent a huge portion of their reserves trying to protect their own currencies (the South African Reserve Bank not being one of them), we are inclined to believe that a little bit of appreciation is probably due.
However, this is merely a short-term tactical call and longer out we continue to believe that EM currencies that need capital are vulnerable to further weakness. The US and Europe appear to be on the mend and this has to ultimately mean that interest rates in developed markets have to start to normalize. The US Treasury market is telling us that liquidity will become less plentiful in the months and years to come and this is not bullish for countries that need global capital.The Rand is not Alone