South Africans had become so accustomed to the rand plateauing around the R13.70/$ mark that the rand’s recent rally came at a surprise to many. Having peaked at R13.50/$ in early June, the rand is now the top performing emerging market currency – despite South Africa’s economic woes.
Bianca Botes, Director at Citadel Global, explains how we got here and why there is a need for cautious optimism when it comes to the rand’s recent rally, which has already started to subside, trading at R13.72/$ on 14 June.
FACTORS DRIVING THE RAND
“We tend to think that local elements affect the rand, however, now more than ever, local elements are really on the back burner. South African politics, and even economics are really playing second fiddle to the global environment and events,” says Botes.
The key themes that led to the rand’s recent rally include:
- A WEAKER DOLLAR
The US deployed record stimulus over the past year in attempts to fight the Covid-19 pandemic and avoid a recession, and the rest of the world followed suit. This led to excess liquidity in capital markets, and ultimately yield-seeking behaviour which drives investors towards assets such as the rand, regardless of underlying risks. In the coming months, treasury and forex specialists will be carefully monitoring the Federal Reserve’s stance, which will be driven by inflation as well as the labour market.
While the Federal Reserve System (Fed) has signaled that tapering down of Quantitative Easing (QE) is becoming topical, we are still quite a while away from seeing a turnaround in monetary policy. This cautious stance by the Fed continues to plague the dollar and is assisting the rand in gaining momentum.
“When comparing commodity cycles with the local currency, the correlation between strong commodity prices and a strong rand cannot be ignored,” says Botes. There has been a lot of talk about a commodity ‘super cycle’ and, while many analysts argue that South Africa, a major exporter of commodities, will not enter a super cycle, the strong commodity process is beneficial to the rand and other commodity-driven currencies.
SUSTAINABILITY OF THE RAND
“Although the rand has run out of steam for the time being, I would be careful of leaning towards a weakening rand just yet. These levels continue to be rather appealing to any entity looking to hedge imports, or individuals looking to externalise funds, says Botes, noting that the conservative Fed will continue to be beneficial for the rand.
“Economic growth, coupled with inflation will see the Fed review policy towards the end of the year. In an environment where we see a tightening of monetary policy, we will likely also see a correction in the rand,” says Botes.
From a technical perspective, there is quite a bit of support, and given the recent rally, Botes believes the rand could be running out of steam. There are some pitfalls to be considered:
- Tightening of global monetary policy at a quicker than expected pace- should inflation increase at a pace faster than anticipated, Central banks could increase interest rates and taper down on QE much sooner than expected.
- Local Covid-19 cases and the consequences of lockdown he on the local economy are detrimental, given the lack of growth and high unemployment South Africa is experiencing
- Partial shift in focus back to local fundamentals:
- Poor fiscal metrics- the fiscal metrics/ financial situation of government has been in the spotlight for a sustained period, and a reduction in government wage bills remans crucial to alter the position.
- Sluggish economic growth- the South African economy faces many structural and reformative issues that impede on growth.
- Unstable electricity supply- ongoing load shedding not only subdues the output of the local economy, but also deters offshore investment.
- High unemployment- SA currently at the highest levels since inception of the unemployment survey
In conclusion, while the rand has surprised market watchers in the recent months, one should not discount the looming risks at play and many analysts agree the rand will likely trade closer to R15/$ as we approach Q3 and Q4 of 2021. For now, importers continue to enjoy the stronger rand, and it will be interesting to see any movements once US President Joe Biden’s promised Pfizer vaccine donations reach South African shores.