logo

What does Powell’s Fed have in store for the rand?

PUBLISHED: Fri, 23 Mar 2018 12:26:59 GMT

Share

Jameel Ahmad | FXTM

This week we saw new Federal Reserve Chairman Jerome Powell take the helm for his first FOMC meeting as Fed chair.  The Federal Reserve raised interest rates for the sixth time since the Federal Open Market Committee commenced raising interest rates from its record lows in December 2015, but the Rand actually strengthened in the aftermath of the decision. Does this make the Rand resilient to US interest rate increases?  What could the latest U.S central bank decision mean for the Rand and South Africa going forward? FXTM’s Global Head of Currency Strategy and Market Research, Jameel Ahmad, shares his views.

Rand

We’ve seen it happen before; central banks build market expectations with hawkish promises and are then forced to take action to avoid causing shocks. Powell’s optimism over the U.S economy meant that investors had all but priced into the Dollar four interest rate rises for 2018.

The Federal Reserve’s hands were tied, even if inflation figures hadn’t met expectations the central bank would have had to raise interest rates this week to prevent a shock in volatility. Unfortunately for Powell, a half-hearted dovish hike wasn’t enough to convince the markets that his Fed was still hawkish on the Dollar.

Powell failed to commit to four interest rate rises for 2018, sending the USD tumbling in the process. Powell’s caution during his conference and statement was noted, he stated that economic data is not showing signs of accelerating inflation, and does not support more US interest rate rises than have already been priced in at three for 2018.

The fact that the ‘dot plot’ – the de facto forecast from which the markets take their lead – remained set at three hikes for the year also disappointed the markets, and the Dollar Index dropped to its lowest level since February 19 in early trade Thursday morning.

This is potentially good news for both the South African economy and Rand short-term. Had the Fed upgraded the dot plot to four interest rate hikes as expected, then we would likely have seen the Rand decline on Dollar strength. For an emerging market, the threat of higher interest rates typical sparks capital outflows — a weaker Dollar staves that off a little longer.

However, Wednesday’s FOMC outcome is not unlikely to keep the greenback down for long. The Fed is still relatively hawkish (if not quite aligned to market expectations) and three interest rate rises throughout the year will likely support the Dollar long-term. A strengthening Dollar could negatively impact the South African economy.

Capital outflows and a reduction in foreign investment is bad news for service industries such as retail, tourism and real estate, while a strengthening Dollar increases the cost of imports and lessens export revenue. Gold’s inverse relationship with the greenback is another bugbear.

The expectation of higher interest rates will likely reduce demand for the zero-yielding metal, driving down its value.

Of course, we’re assuming at this point that the Washington pantomime fails to influence the greenback long-term. With trade war fears threatening escalation and three investigations into Russian collusion currently live, the Dollar has a rocky road ahead of it in 2018.

Even if the African continent seems isolated away from the threat of a Trump trade war, it doesn’t mean that the Rand will not feel the brunt of market uncertainty. Concerns that President Trump is set to intensify his tariffs against China in the coming days and weeks are likely to keep investors on edge. Any signs of sudden selling pressure in the stock markets is going to risk hurting appetite towards emerging assets, like the Rand.

A Trump trade war is not seen as positive for emerging market currencies and could derail the recovery in the Rand, which currently stands at 4.40% year-to-date.


Get the best of CNBC Africa sent straight to your inbox with breaking business news, insights and updates from experts across the continent. Sign up here.