Currency experts are warning that the rand could weaken significantly as the US Federal Reserve begins a new rate-cutting cycle.

According to RMB currency expert John Cairns, each of the last four cutting cycles has seen the rand blow out.

With the US Federal Reserve all but certain to start cutting rates at the end of July, Cairns said that he expects this cycle to repeat itself in the coming year and a half.

Cairns presented a chart showing the basis of the argument, as it shows the Fed rate against rand weakness since 1994.

“In each period the rand weakened. In each of the four instances (since 1994) there has been a Fed cutting cycle, the rand has seen a blow-out,” he said.

In the graph below, the orange areas highlight the 18 months after the Fed cut in each cycle.

Chances of a rand blow-out?

To track the chances of a blow-out, Cairns said that RMB has constructed an index to assess the current risks facing the currency.

Cairns said that the index is based on US data which means that it correctly estimated the last four Fed-related blow-outs, but did not capture the 2015/2016 blow-out caused by ‘Nenegate’.

“Assuming the Fed cuts this month, the index shows a 47% probability of a rand blow-out in the next year. A blow-out is defined as a 30% or more move in the dollar/rand rate.”

Good news first?

When looking at these previous episodes in more depth, Cairns said that the rand typically appreciates in the first months after the cut.

“If history repeats itself then dollar/rand will trade well into R13 in the next few months. The much more important point is that after the initial appreciation, the rand weakened sharply.

“These moves are huge in size and on average the rand lost 30% of its value within 12 months and 40% of its value within 15 months. If this repeats then the dollar/rand will trade to R20 sometime next year.”

Cairns said that it is not the Fed cuts themselves that cause the rand weakness, and the cuts are in fact positive in many ways.

He added that Federal Reserve typically cuts rates because it is worried about slowing economic growth in the US economy.

“When this weakness occurs, we see risk-off, commodity price weakness, and pressures in emerging markets,” he said.

Cairns’ full presentation can be viewed below:

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