Seasonal liquidity crunch is bad news for rand

An expected seasonal dollar-liquidity crunch means the outlook for the rand is anything but merry as the year draws to a close.

Funding requirements of large European and Japanese banks going into year-end, together with the Federal Reserve’s tighter monetary policy, will probably lead to greater demand for dollars and rising offshore funding costs, according to Mehul Daya and Walter de Wet. That would weigh on the rand, one of the emerging world’s most-traded currencies, they wrote in a note to clients.

“Global dollar-liquidity shortages, both structural and seasonal, remain a key risk to the outlook for the rand,” said Daya and De Wet, who correctly predicted in June that South Africa’s currency could weaken to above R14 per dollar as global financial conditions became more restrictive. “Greater demand for U.S. dollars and rising offshore U.S. dollar funding costs, accompanied by currency volatility, will likely not bode well for the carry trade.”

Their call, “We expect the rand to be volatile, with a weakening bias toward the R14.50 area in the short term.” The currency was little changed on Monday at R14.3672 per dollar after sliding 3.3% in the previous two trading days.

Nedbank is echoing concerns raised by the South African Reserve Bank in its bi-annual Financial Stability Review last week, when it said that tightening financial conditions are a “medium-likelihood” but potentially “high-impact” risk which would result in a repricing of assets, exchange-rate deterioration and rising debt.

South Africa’s currency is particularly vulnerable to emerging-market selloffs triggered by rising borrowing costs in developed countries. Daily trading in the rand is equal to about 18% of the country’s gross domestic product, according to Renaissance Capital. By that measure, it is the most liquid currency in the world, making it easy for traders to take bets - and offload them in a risk-off environment.

The dollar squeeze, which has seen Bloomberg’s gauge of the greenback rise 8.8% since February, may worsen in 2019, according to Moody’s Investors Service.

“Global financial conditions will continue to tighten in 2019 as monetary policy normalisation gradually proceeds in advanced economies, particularly in the U.S.,” Moody’s analysts including Anne van Praagh, Alastair Wilson and Elena Dugg wrote in a report. Emerging markets, especially those, like South Africa, which have limited scope to raise interest rates, “will remain vulnerable to spillovers” from “a likely further tightening of global liquidity,” they said.

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