Executive Summary

• The recent slide in the rand has little to do with local developments, instead as we have maintained throughout the year, it is all about the shrinking pool of Global $-Liquidity (see feature chart).

• The lack of market liquidity combined with emerging market contagion from Turkey and Russia is exerting downward pressure on the rand. The Turkish lira is under severe pressure, largely on the back of a central bank that lacks credibility and independence to act on run-away inflation. The weaker lira which has also seen Turkish bond yields much higher is threatening to erupt into a full-blown balance-of-payment problem as Turkey’s foreign reserves continues to decline. At the same time, the Russian rouble is sharply weaker as the US imposes more sanctions on Russia.

• The dollar is also stronger in its own right. US dollar strength is evident against the euro. The EURUSD is trading below the 1.15 level for the first time since July 2017.

• As far as the dollar is concerned and the risk of further downside risks escalating, we focus on our proprietary Global $-Liquidity indicator which measures excess global money supply (USD terms) relative to money supply growth in the US economy. We monitor this closely because the USD is still the most used, and only reserve currency in the world. How does Global $-Liquidity work? When the growth in global money supply (USD terms) exceeds the growth in money supply from the US economy, it implies that that there is excess dollars in the global economy, leaving financial conditions accommodative and the carry-trade attractive. This benefits riskier assets such as EM currencies. The reverse also holds - when the growth in global money supply is less than the growth in money supply from the US economy, it creates a shortage of dollars in the global economy. This shortage results in tighter financial conditions and makes the carry-trade (and risky assets) less attractive.

• The latter scenario has been the case for most of 2018 not only because of major central banks (in particular the Fed) tightening monetary policy, but also because protectionist global trade polices dampen the prospects for global growth.  This is the main driver of our bearish view on the rand relative to Bloomberg consensus (consensus at R13.10 vs. Nedbank R13.85 for year-end 2018).

• For the rand to depreciate above R14.50 on a multi week/month basis we believe four factors need to materialise. Firstly, commodity prices need to decline sharply (we remain cognisant that the rand remains a commodity currency). Secondly, the credit cycle in China must weaken despite fiscal and monetary stimulus by the authorities. Thirdly, our Global $-Liquidity indicator must move into negative territory (it has merely slowed down lately) and lastly downside risks from the local economy must gain further momentum.

• From a technical perspective, we recommend keeping an eye on the USDZAR resistance level of R15.20 and USDZAR support level of R14.39.