Markets are cheering as the end of the tightening cycle in large, developed economies looks more certain. In the US, softer activity data and dovish remarks from members of the federal open market committee in the lead-up to last week’s rate decision, the Federal Reserve’s decision to leave rates unchanged, and worse-than-expected employment data on Thursday, sank interest rate expectations and pulled the dollar weaker.
Where before financial markets were pricing in some possibility of further hikes, these now look less likely. From equities to emerging market currencies, risky assets cheered. The rand has gone along for the ride, strengthening to R18.30/$, a level last reached in August.
The market seems to think we are about to get the global monetary policy break we so desperately need. The discounted probability of another hike in the US is now at 9%, down from more than 50% a week ago. The European Central Bank is now priced to cut by April 2024. A week ago, the market was looking at a June cut. SA rates are now priced for the next move in rates to be a cut, between the May and July meeting in 2024. A week ago the market was pricing in an even chance of another hike in the next two meetings.
The shift in the outlook for US rates has prompted an important switch in the market narrative. Where before the story was “rates higher for longer”, it is now oncoming weakness and the infamous “Fed pivot”. This has led to an easing of financial conditions that benefits risk assets in general, and the rand.
The question of a US recession remains outstanding. If, as some believe, the US will manage to avoid recession, then the worst for risky assets is behind us and the rand will go from strength to strength. However, if the nascent slowdown in US economic data manifests in a recession, however mild, financial conditions could tighten and risky assets would sell off. I am more in the latter camp.
In the meantime, market narratives can change overnight, and there is enough uncertainty between camp “no landing” and camp “recession” that wild swings between strength and weakness in risky assets would not surprise me. For those of us riding the rand roller-coaster it could mean a few more months of volatility.
The next big unknown is what will happen to growth outside the US. To the extent that strength in the dollar has been due to more favourable growth in the US relative to the rest of the world, stabilisation in global demand would assist in stabilising other assets.
Where the US has powered ahead on the back of unprecedented government transfers to households and, more recently, increased government expenditure, the rest of the world has not been so lucky. Between the dampening effects of monetary policy tightening, the ruinous impact of high inflation on real incomes and the collapse of the Chinese growth engine, global demand has been in the doldrums.
There are signs that global demand and manufacturing are stabilising. Inflation is falling, the effect of the negative fiscal impulse is waning, and rates have stopped rising. The globe is not powering on all cylinders, but the worst might be behind us. Chinese authorities have managed to stabilise demand there and could yet unleash more stimulus. A resurgence in global demand will help risky assets, but this picture will take some time to unfold. In the meantime, we wait.
For rand watchers the question remains how to read the recent shift in momentum. Is this the beginning of a long streak of strength? It helps that the worst of the rate hikes is behind us. It helps that we are close to the beginning of the easing cycle. It helps that global growth seems to have found a floor, though confirmation is needed here.
That said, the threat of a US recession looms, and until we have a clearer picture here, caution is advised.
• Lijane is global markets strategist at Standard Bank CIB.
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