South Africa’s rand weakened as financial watchdog flags risks

Reuters: South Africa’s rand weakened against a stronger U.S. dollar on Friday, as an international financial crime watchdog added South Africa to its list of countries needing special scrutiny.

South Africa’s Rand weakened

 At 15:26 GMT, the rand traded at 18.4225 against the dollar, about 1% weaker than its previous close. The dollar index, which measures the U.S. currency against six others, was at a seven-week high after a set of strong U.S. economic data. Global watchdog the Financial Action Task Force (FATF), which sets standards on combating money laundering and illicit financing, added South Africa to its “grey list”on Friday, a reputational knock for Africa’s most advanced economy.

Being added to the list means that countries are subject to increased monitoring by the FATF on concern that they are at higher risk for money laundering and terrorist financing. The listing is likely to increase domestic banks’ cross-border funding costs and raise transactional and administrative costs across the board, said Jeffrey Schultz, Middle East and Africa chief economist at BNP Paribas. “We also think that such a headline could create further headwinds to already fragile ZAR sentiment which is grappling with severe levels of electricity supply cuts,” he said in a note. The rand fell to a new 2023-low of 18.4850 to the dollar after the news, but then regained some ground.

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South Africa’s central bank and National Treasury both noted the watchdog’s decision and said they would work to address its concerns. The Treasury said it expected a limited impact from the grey-listing on financial stability and the costs of doing business with South Africa. On the stock market, the Top-40 index closed around 2.8% lower and the broader all-share fell around 2.6%. The government’s benchmark 2030 bond was weaker, with the yield up 1.5 basis points to 10.130%.

British Pound

Reuters: The pound held steady on Friday, thanks to a modest lift from data that showed an improvement in UK consumer sentiment, but the currency was still headed for its first monthly drop since September. British consumers have become more optimistic about their personal finances and the outlook for the economy, but their mood is a long way below where it was prior to the COVID-19 pandemic, market research firm GfK said on Friday. Sterling was last flat against the dollar at $1.20165. The pound has lost 2.4% in value so far in February, the first month it has fallen since September’s near-4% fall to a record low. Against the euro , the pound was unchanged on the day at 88.17 pence per euro. Broad-based weakness in the yen sent the pound up by as much as 0.5% to 162.62 yen, with incoming Bank of Japan Governor Kazuo Ueda saying it was appropriate to keep ultra-loose monetary policy.

A pick-up in consumer sentiment does not always translate into a pick-up in spending, as evidenced by a flat read of retail sales for February from the Confederation of British Industry on Thursday. But energy prices are finally receding from last year’s punishing highs, and the UK economy is not looking quite so bad as expected just a few short weeks ago, according to this week’s Purchasing Management Index (PMI) surveys on business activity, which showed an unexpected bounce in early February. “Following on from Tuesday’s strong PMI release, the UK outlook has received another boost today in the form of a big jump in GFK consumer confidence. This has now returned to levels not seen since last April,” ING strategist Chris Turner said. “At the margin, this will make the Bank of England’s life harder as it seeks to cool aggregate demand to soften inflation,” he said.

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The grind lower in the pound in February has, for once, had less to do with the weakness in the British economy and more to do with the view among investors that the Federal Reserve still has some way to go before it can stop raising interest rates, which has given the U.S. dollar this month its biggest boost since September. “On sterling, we think this year will be more about pricing out bad news and less about pricing in good news, but 2024 looks more promising to us,” Michalis Rousakis, a strategist at BofA, said. The BoE is widely expected to raise rates to a peak of around 4.6% by August, from 4.00% now. Money markets show traders believe UK rates will be around the 4.5% mark by the end of the year. The Fed, meanwhile, is expected to raise rates to 5.35% by July, from 4.75% now, with little chance of any kind of drop before the end of 2023.

US Dollar

Reuters: The dollar held firm near a seven-week peak on Monday, after a slew of strong U.S. economic data reinforced the view that the Federal Reserve will have to raise interest rates further and for longer. Data on Friday showed U.S. consumer spending rebounded sharply in January, while inflation accelerated. The personal consumption expenditures price index, the Fed’s preferred gauge of inflation, shot up 0.6% last month after gaining 0.2% in December. The dollar index , which measures the U.S. currency against six major peers, was up 0.038% at 105.21, just shy of the seven week high of 105.32 it touched on Friday after the hotter-than-expected data was released. The index is up 3% for February and set to snap a four-month losing streak as investors adjust their expectations of U.S. interest rates remaining higher for longer. The market is now pricing rates to peak at 5.4% in July and remain above 5% through the end of the year. “We’re in a bit of a nervous environment,” said Moh Siong Sim, currency strategist at Bank of Singapore, adding that the market is uncertain about the future pace of Fed interest rate hikes.

“Whether (Fed) can maintain 25 basis point hike? Or will they be forced to re-accelerate the pace? So I think these are the questions that the market is grappling with,” Sim said. “And there is no clear answer right now.” Fed policymakers speaking on Friday did not push for a return to last year’s jumbo rate hikes, suggesting that for now central bankers are content to stick to a gradual tightening path despite signs that inflation is not cooling as they had hoped. The Fed earlier this month raised rates by 25 basis points and is expected to increase by the same margin at its March 21-22 meeting, though some analysts see the possibility of a 50 basis points hike if inflation stays high and growth remains strong. “We now believe it is a much closer call that officials hike by 50 basis points in March than our earlier 25 basis points assumption,” said Kevin Cummins, chief economist at NatWest Markets. “We put the odds at about 60% that the FOMC hikes by 50 bps.”

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Markets have also nudged up the likely rate tops for the European Central Bank and the Bank of England. The two-year U.S. Treasury yield, which typically moves in step with interest rate expectations, was up 3.4 basis points at 4.839%, just shy of the three-month high of 4.840% it touched on Friday. The euro was flat and pinned near the seven week low of $1.0536 it hit on Friday. Sterling was last at $1.1943, down 0.01% on the day. The Japanese yen strengthened 0.12% to 136.29 per dollar, having slipped to more than two month lows of 136.58 earlier in the session. Incoming Bank of Japan Governor Kazuo Ueda said on Monday the merits of the bank’s current monetary policy outweigh the costs, stressing the need to maintain support for the country’s economy with ultra-low interest rates. The Aussie was 0.25% lower at $0.671, having touched near two month low of $0.6705. The kiwi fell 0.28% versus the greenback at $0.614.

World Markets

Reuters: Asian shares slipped on Monday as markets were forced to price in ever-loftier peaks for U.S. and European interest rates, slugging bonds globally and pushing the dollar to multi-week highs. Investors are braced for more challenging U.S. data including the closely-watched ISM measures of manufacturing and services, the latter being especially important following January’s unexpected spike in activity. There are also at least six Federal Reserve policy makers on the speaking diary this week to offer a running commentary on the likelihood of further rate hikes. China has manufacturing surveys and the National People’s Congress kicks off at the weekend and will see new economic policy targets and policies, as well as a reshuffling of government officials. MSCI’s broadest index of Asia-Pacific shares outside Japan fell 0.5%, having shed 2.6% last week. Japan’s Nikkei eased 0.4% and South Korea 0.9%. S&P 500 futures were flat, while Nasdaq futures edged up 0.1%. Strong data on spending and core prices saw the S&P 500 crack support at 4,000 on Friday and retrace 61.2% of this year’s rally.

Fed futures now have rates peaking around 5.42%, implying at least three more hikes from the current 4.50% to 4.75% band. Markets have also nudged up the likely rate tops for the European Central Bank and the Bank of England. Bruce Kasman, head of economic research at JPMorgan, has added another quarter-point hike to the ECB outlook, taking it to 100 basis points. Germany’s 2-year bond yield broke above 3.0% on Friday for the first time since 2008. “The risk is clearly skewed toward greater action from the Fed,” says Kasman. “Demand is proving resilient in the face of tightening and lingering damage to supply from the pandemic is limiting the moderation in inflation,” he added. “The transmission of the rapid shift in policy still underway also raises the risk of a recession not intended by central banks.” The Atlanta Fed’s influential GDP Now tracker has the U.S economy growing an annualised 2.7% in the first quarter, showing no slowdown from the December quarter. Higher rates and yields stretch valuations for equities, especially those with high PE ratios and low dividend payouts, which includes much of the tech sector.

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Shares in the United States trade at a price to earnings multiples of around 17.5 times forward earnings, compared to 12 times for non-U.S. shares. Ten-year Treasury bonds also yield more than twice the estimated dividend yield of the S&P 500 Index, and with much less risk. With the earnings season almost over, around 69% of earnings have surprised on the upside, compared to a historical average of 76%, and annual earnings growth is running around -2%. The upward shift in Fed expectations has been a boon for the U.S. dollar, which climbed 1.3% on a basket of currencies last week to last stand at 105.220. The euro was pinned at $1.0548, after touching a seven-week low of $1.0536 on Friday. The dollar scaled a nine-week top on the yen to stand at 136.40, aided in part by dovish comments from top policy makers at the Bank of Japan. The rise in the dollar and yields has been a burden for gold, which shed 1.7% last week and was last lying at $1,812 an ounce. Oil prices edged higher as the prospect of lower Russian exports was balanced by rising inventories in the United States and concerns over global economic activity. Brent gained 35 cents to $83.51 a barrel, while U.S. crude rose 34 cents to $76.66 per barrel.

Published by the Mercury Team on 27 February 2023

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