One of the big factors that has helped to support the rand exchange rate, despite SA’s efforts to shoot itself in the foot politically and economically, is a favourable global environment.
US monetary policy in particular has favoured a continuing wash of capital inflows into emerging markets, SA included. Although the era of ultra-low yields is coming to an end, with the US Federal Reserve having begun to raise interest rates and reduce its balance sheet, the Fed’s careful pace has kept the emerging market party going.
That was affirmed again last week when the Fed open market committee set in play a plan for reducing the bloated $4.5-trillion balance sheet the Fed built up in the wake of the financial crisis as it implemented quantitative easing. At the same time, Fed chairwoman Janet Yellen signalled that she would probably lift short-term interest rates for the fifth time since the financial crisis.
SA has benefited from R63bn of foreign inflows into its bond markets in the year to date
This time, it has been nothing like the "taper tantrum" of 2013, when the Fed first signalled the end of quantitative easing and emerging market currencies crashed. This time, Yellen has made it clear that the pace of monetary policy normalisation would be gradual. The announcements had been largely priced in by the markets and although the dollar strengthened and the rand continued to slide, it was nothing dramatic.
As Reserve Bank Governor Lesetja Kganyago pointed out after last week’s monetary policy committee meeting, the Fed’s confirmation of its approach, along with the accommodative monetary policy approach of the European Central Bank, were expected to continue to create favourable conditions for capital flows to emerging markets.
SA has benefited from R63bn of foreign inflows into its bond markets in the year to date. In theory, the favourable global environment for those portfolio inflows could continue, helping SA to finance its current account deficit despite political and economic uncertainty and the prospect of further ratings downgrades.
However, SA and other emerging markets should not be too complacent about a favourable Fed, because there are some question marks and risks in relation to US monetary policy.
One question relates to the big US inflation puzzle. The Fed bases its approach in essence on the notion that higher economic growth levels will lead to stronger employment growth and, in a context in which there is close to full employment already, that will lead to upward pressure on inflation, which the Fed then addresses by raising interest rates.
The trouble is that the theory, mysteriously, doesn’t seem to be holding. The US economy is motoring along and employment levels are rising, yet inflation isn’t doing what it was expected to do. US core inflation has been undershooting targets for five years, with inflation slowing to well below the 2% target and coming in consistently below expectations.
There are various explanations, but the Fed seems to be treating this as a temporary phenomenon. If monetary policy makers were to decide the dynamics were more permanent, it is possible they might review the consistent approach global markets have come to rely on and it is not clear what that would mean for interest rates in the US.
The other much bigger risk is that Yellen’s term comes to an end in 2018 and, although she does seem to be on US President Donald Trump’s short list of possible appointments, so are others, such as Gary Cohn, who is known to favour a harder line on monetary policy. Nor is Yellen’s replacement the only decision in Trump’s unpredictable hands: there are four other vacant positions on the Fed board he will have to fill.
A tougher Fed chairman and board could change the US and global dynamics significantly — a risk to which SA and other emerging markets should be alert and responsive.