BE CAREFUL what you wish for. That's the thought that came to mind last week, when the Dubai mini-crisis sent the rand 20c weaker in a very short space of time. Those wishing for a weaker rand might find it's the market - and not the Reserve Bank - that grants them their wish.
The Dubai issue is a timely reminder that the global economy isn't out of the woods yet. And, as we have seen in the past, when there's fear about the global economy, there's a rise in risk aversion.
This loss of appetite for risk translates into a stronger dollar, as global investors seek the safe haven of US government bonds. (Yes, it's ironic that the ultimate cause of the global crisis was the US, and that that country should still be seen as a safe haven. Go figure.) And a stronger dollar hits the rand.
So far, the rand - and the rest of the world - has weathered the Dubai mini-crisis well. The rand is back to testing its best levels for the year.
Risk appetite remains healthy. But, increasingly, commentators are warning that it's too healthy. They are saying that new bubbles are forming in emerging markets and that there's a risk that those bubbles will burst, resulting in a new crisis for the global economy.
For SA, if those bubbles burst, it would probably mean a significant weakening of the rand - without any intervention from the central bank.
If there are doubting Thomases out there about whether bubbles are being formed, it's worth pointing out that the MSCI emerging markets equities index is up about 81% from a year ago, against a rise for the whole world's markets of about 27%. There's also been a surge in the value of emerging market and commodities-based currencies. The rand has gained more than 25% in value against the dollar this year.
Carry trade carry-on
This week Charles Goodhart, a former member of the Bank of England's monetary policy committee, referred to the rise in global financial markets in 2009 and warned that central bank action could let another bubble develop.
Writing in Britain's Financial Times, he argued that the big injections of liquidity into the banking system by central banks - known as quantitative easing - now posed a risk and should be ended.
He said: "If the authorities go on blowing up financial markets too much, at some point yet another bubble will develop. The last time the financial bubble burst, the taxpayers got soaked. There will not be a next time for this support mechanism."
New York University's Professor Nouriel Roubini, who famously predicted the global meltdown, has warned about bubbles forming as a result of very low US interest rates.
Bloomberg news service reports Roubini said investors worldwide were borrowing in dollars to buy assets including equities and commodities, fuelling "huge" bubbles that might spark another financial crisis.
"We have the mother of all carry trades," Roubini said.
Carry trade is the technical term referring to the borrowing of a currency (say the dollar) at very low interest rates and then investing the proceeds in another currency with higher interest rates (say SA.) The profit is the interest rate differential, and also the strengthening of the currency in which the proceeds are invested.
Even though SA interest rates have dropped a lot, at 7% our repo rate is still much higher than the US official interest rate of 0% to 0.25%. Carry trade is a surefire way of making money if the currency you borrow is likely to be on a depreciating trend (even without the aggravating actions of the carry traders).
Just made for bursting
Some people don't like to take Roubini too seriously, as he is a noted prophet of doom whose gloom started long before the global financial meltdown. But Roubini isn't the only one warning about the carry trade. Germany's new finance minister, Wolfgang Schauble, recently warned about the threat of fresh global asset price bubbles, fuelled by low US interest rates and a weak dollar. His warning echoed that of Chinese officials.
This forced the US Federal Reserve to sit up and take notice. Fed officials, in the last minutes of the Federal Open Market Committee, expressed concerns that near-zero interest rates could fuel "excessive risk-taking in financial markets" but believed the possibility of such an outcome was "relatively low".
The Fed would think the possibility of a bust was relatively slight, because it wants to keep US interest rates low for a long time. The situation is a bit of a catch 22. If the Fed raises rates too soon, it would choke off the US recovery - hitting the world economy.
If it keeps rates low for too long, it risks creating new bubbles. Bubbles which some commentators say have already formed, and will burst - hitting the world economy.
What will it take to prick the bubbles? A hike in US interest rates, when it finally happens, could be the trigger. Roubini said an asset bust may not occur for another year or two as a "wall of liquidity" pushes prices higher.
But even if it takes that long, those calling for a weaker rand might find their prayers answered in a dramatic - and probably highly unpleasant - manner.
- Fin24.com