It’s a race to the bottom

by David Irish | November 30, 2022


This month we consider several indicators that must be considered when reviewing the outlook for the direction of the rand against its major trading partners. The key takeaway is that the US economy and global risk sentiment continue to be the key drivers of global currency movements, irrespective of whether we are looking at the major or emerging market currencies.


US economic conditions 

The US Consumption Outlook

Consumption accounts for two-thirds of US GDP. According to BCA Research, there are two competing views on the US consumption outlook.

On the one hand, healthy balance sheets and large pandemic savings could allow US households to continue spending at elevated levels over the coming months. This is positive for the US economy more generally.

On the other hand, there is the view that the lowest-income consumers have already completely drawn down their pandemic savings. This trend is expected to eventually affect higher-income earners. Furthermore, an increasing number of consumers are now relying on second jobs and credit cards to finance their spending. The rise in multiple job holders partly explains the robustness of recent US job reports, despite participation rates not increasing significantly. The participation rate is the percentage of the population that is either working or actively looking for work1. This indicates that there could be more cracks in the US labour market than meets the eye.

Excess job vacancies

BCA Research’s Counterpoint service concludes that excess job vacancies in the US largely reflect a shortage of labour supply, making a recession more likely. A recession in the US would tend to weaken the US dollar.

There are three potential paths to a soft landing:

First, if the missing millions in the labour force were to return to their former jobs, then vacancies-to-unemployed (V/U) – and thereby, wage inflation – would reduce without any rise in unemployment. There are no indications of this happening. The shortage in labour supply appears to be structural.

Who are the missing millions? There are various theories with the dominant explanations being: baby boomers retiring early, COVID deaths and associated long term illness, and the pandemic prompting people to re-evaluate their lives and choose a more downscaled existence.

Second, if the excess job vacancies were mostly reflecting excess labour demand, then we could reduce V/U – and thereby, wage inflation – by V falling without U rising. However, it is being argued that excess vacancies reflect a shortage of labour supply instead.

The third path to a soft landing would be for labour demand to fall sharply, and for displaced workers to fill the jobs of the missing millions in the labour force – this would cause V/U to decline without U rising. This would be feasible if the missing millions were evenly distributed in the workforce and therefore easily substituted, rather than concentrated amongst those whose skills cannot be easily replaced. Unfortunately, the missing millions are concentrated in the cohort aged 50, whose skills and experience are often difficult to replace.

This all means that killing US wage inflation will mean killing jobs and killing profits.

The minutes from the November 1-2 FOMC meeting reflect this concern leading to the market view that the pace of Fed tightening will slow in December, before pausing in Q1 or Q2 of next year.

Global demand and implications for a global recession

Research recently highlighted the point that Asian trade data does not bode well for the direction of global demand.

Taiwanese export orders in USD terms contracted by 6.3% y/y in October, down from a 3.1% decline in the previous month and short of expectations of a milder decrease. Exports to China and Hong Kong drove the bulk of the contraction, which was broad-based across product categories in October.

Meanwhile, South Korean exports for the first 20 days of November plummeted, contracting by 16.7% from a 5.5% decline previously. Exports to China, the largest buyer of Korean goods, fell by 28.3% over this period.

Asian trade data is a good bellwether of global demand conditions. These indications follow an October contraction in both Chinese imports and exports, declines in Singapore non-oil exports, and contracting new export orders components of Taiwanese and South Korean manufacturing PMIs.

The global manufacturing slowdown, amid the consumption normalization from goods to services, is weighing heavily on Asian trade. Meanwhile, Chinese domestic demand continues to face significant headwinds. Weak income growth, poor private-sector sentiment, structural property market issues, and lingering zero-covid policies are all likely to constrain the efficiency of the stimulus measures, and in turn weigh on Chinese imports going forward.

So, despite the indicators of a looming US recession and its implications for the US dollar these expectations for a global trade recession does not augur well for emerging market risk assets. This would indicate a bias towards the US dollar relative to emerging market currencies such as the rand. It is almost as if there is a race to the bottom with the lead being exchanged in an unpredictable manner.

The only way for any business with foreign exchange exposure to address this uncertainty is to develop and implement and consistently apply a robust foreign exchange risk management policy.


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