Will the US enter a recession and what are the impacts for the rand?

by Trent Wiseman | March 2, 2023

Tight monetary policy has been a prerequisite for recessions in the US since the end of World War Two in 1945. Due to rapidly rising inflation that began in the third quarter of 2021, the Federal Reserve started the process of tightening monetary policy in the economy by raising interest rates, known as the Federal Funds Rate.

Figure 1 illustrates that monetary policy in the US officially became tight in November 2022. Historically a recession has occurred within one year of tight monetary policy.

figure 1

However, there have been significant improvements in multiple data releases from the US which have allayed some of the fears that the Fed’s aggressive rate hiking cycle will result in a recession. January’s non-farm payroll report, an indicator of all private and government sector jobs, was the first of these positive data releases. The report showed that 517 000 jobs had been created, almost three times the consensus forecast of 185 000. The second positive data release from the US was month-on-month (MoM) retail sales for January 2023 which jumped 3%, again significantly outperforming the consensus forecasts that came in at 1.8%. The new export orders component of manufacturing PMIs (Purchasing Managers’ Index: an index of the prevailing direction of economic trends) are rebounding strongly, suggesting global trade could improve in the months ahead. Energy prices continue to bottom in Europe, which will be a meaningful boost to the manufacturing sector and alleviate the tax on household incomes and further boost household consumption. In Japan, the future conditions component of the Economy Watchers Survey, a good gauge for the sentiment of small and medium-sized businesses, rebounded strongly in January. There are positive economic signs out of China. Passenger traffic is picking up as the country re-opens which will support economic activity by boosting domestic spending. The Caixin services PMI has been accelerating since November. As more Chinese citizens travel abroad and spend, this will be a boost to the global services PMI. Bank loans are also increasing suggesting an improvement in consumer sentiment. There are signs which point to a build-up of excess liquidity in the system and which has usually been a precursor to increased imports. The increase in Chinese imports will be welcomed by much of the world and which will bode well for global growth.

These positive signals show that there might be a chance that the US manages to avoid a recession in the latter half of 2023 or early 2024. However, it must be noted that MoM economic data is extremely volatile and must be viewed in relation to the overall trend. As we can see in Figure 2, despite January’s positive data, both non-farm payrolls and retail sales are down significantly from their respective highs in both 2021 and 2022.

figure 2

If the US does enter a recession, this could bode ill for the South African rand as the dollar has strengthened during every recession since the 1980s. See Figure 3. Barring South Africa’s local struggles, namely the load-shedding crisis and the Financial Action Task Force (FATF) adding the nation to their grey list, the rand is set to suffer from additional pressure brought on by the stronger dollar. Technical analysis shows that the greenback is set for a rebound as it enters the oversold territory. The DXY Index, which tracks the strength of the dollar against a basket of six currencies, has bounced off the strong support level of 100, after reaching a high of 114.78 in October of 2022.

figure 3

The team at BCA Research believes that the DXY will strengthen to a technical support level at 108. Any further strengthening of the dollar will be subsequent to the moves in the inflation rate and how long the Fed keeps interest rates elevated before they begin to implement expansionary monetary policy by lowering their interest rate.

A perfect storm of a continued hawkish Fed, coupled with a strengthening dollar and increased load shedding could see the rand weaken against the dollar to 18.75, and possibly 19.00 in a worst-case scenario. However, according to the analysts at BCA Research, if the Fed manages the interest rate cycle well and can achieve a soft landing (whereby the US economy reaches potentially flat growth but avoids a recession) the dollar is likely to continue its downward trend.

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