Rand under pressure as dollar flexes – here’s where it could be heading in the next few months

 ·18 Aug 2022

The rand lost further ground against the dollar in mid-morning trade on Thursday (18 August) having shed nearly 1.7% against the greenback a day earlier.

Reuters reported that the dollar continued to flex following minutes from the Federal Reserve’s July meeting that pointed to US interest rates staying higher for longer to bring down inflation.

Bianca Botes, director at Citadel Global, said that the rand came under pressure on Thursday as EU GDP and local retail sales missed the mark. Both came in lower than market expectations, adding to growth concerns across the globe.

“Meanwhile, the Fed minutes from last night brought no surprises, with the Fed maintaining their stance of higher interest rates for longer, pointing to a steady rate hiking trajectory in coming months.”

Local data revealed that June retail sales declined more than anticipated, suggesting that the economy contracted in the second quarter with a recession not out of the question.

In mid-day trade the rand traded at the following levels against the major currencies:

  • Dollar/Rand: R16.70 (2.06%)
  • Pound/Rand: R20.12 (1.61%)
  • Euro/Rand : R16.97 (1.97%)

Annabel Bishop, the chief economist at Investec, said in a note this week that despite its weak level against the dollar, the rand is likely to strengthen below R16.00 by the end of this year. It currently averages R16.75 for the first half of Q3.22, but is likely to drop down towards R16.00, if not stronger by the end of this quarter.

“The second and third quarters of the year tend to be risk-averse quarters for global financial markets, while September/October usually sees increased risk-taking, which benefits the rand and other EM currencies, as well as EM portfolio assets, and other risk assets.

“That is, the rand tends to strengthen in the fourth quarter of the year as key market players reposition for higher risk/reward, while the middle two quarters are usually weak quarters for the rand on thin market trading which exacerbates sensitivity to risk,” said Bishop.

The volatility of the rand is still lower than a number of other EM countries, running closer to the middle of the Bloomberg basket than at the high end as it did in Q1.22, and generally, EM currency volatility is higher than they were in Q1.22, reflecting elevated risk, the economist added.

“The risk is tilted towards slower economic growth this year, particularly in Q4.22 and H1.23, and this could see the rand not make as markedly substantial gains as it usually does in the first and last quarters of the year on seasonal influences.

“There is increased global synchronisation on interest rate hikes (and acceleration in these hikes), which is adding to risk-on in financial market sentiment on global growth concerns, and so the current heightened risk-sensitive environment.”

Bishop pointed out that uncertainty heightens risk aversion, which has added to the momentum in the rand’s depreciation from R14.53 against the dollar at the start of Q2.22 to a weak point of R17.26 a few weeks ago. The rand is expected to see strength into and over Q4.22, but risks remain, she said.

True value

A strong rand, when compared to the US dollar, often makes citizens feel better about the state of affairs in South Africa, said Michael Kruger, senior investment analyst at Morningstar Investment Management.

“When the value of the rand climbs, so does our optimism about the growth and recovery of the country, while a weak currency fires up all the negative sentiment we read about in the press.

“We have no shortage of problems in our country – whether it be concerns about rising food and fuel prices, subdued growth, unemployment, electricity shortages, political infighting, a weak fiscal outlook, and social unrest.”

Kruger noted that the value of the rand is only partially affected by local factors.

Some emerging market currencies can be extremely volatile over time, with the performance of the Turkish Lira over the past two years being a case in point. “What is evident is that the rand has actually held up relatively well against the US dollar, when compared with most other emerging market currencies,” he said.

The US dollar has been extremely strong against most major developed market currencies over the past couple of years. This has been exacerbated by the willingness of the US Federal Reserve to hike interest rates in 2022 in response to rising inflation, while other major global developed market central banks have been rather dovish in comparison, the analyst said.

The IMF’s research showed that the main driver behind the movement of the rand relates to global factors and macro-economic events in the US. In other words, the level/value of the rand is often influenced and determined by the US dollar movement.

Kruger said that roughly 30% of all rand volatility could be attributed to global macro-economic factors which influenced the US dollar and hence the rand.

“As a small, open, emerging market that makes up less than 1% of the world economy, we are more likely to be affected by what is happening globally rather than in our own country. This is further exacerbated by the fact that the rand is one of the most liquid and tradeable currencies when compared to other emerging market currencies globally.”

Kruger said that often when there is global risk aversion and investors flock to safe-haven assets, the rand acts as a proxy for all assets perceived to be risky by global investors. This can often lead to the rand depreciating.

A further factor is commodity prices. Roughly 30% of the volatility of our currency was a result of commodity price volatility. In the first half of the year, the rise in commodity prices has largely benefited South Africa, the analyst said.

“Recently, commodity prices have started to fall from their peaks, largely as a result of concerns around the global growth outlook and the increased possibility of a recession in some major geographies, particularly those in close proximity to the Russia/Ukraine conflict in Central and Eastern Europe.

“The concerns around global growth have been exacerbated by interest rate hikes from central banks in response to stubbornly high inflation.”

What is the fair value for the rand?

Currencies can deviate significantly from fair value over time, however, over the long term, movements between currencies should reflect inflation differentials between two countries, said Kruger. “Due to the relatively higher inflation environment in South Africa, we would expect the rand to depreciate against most developed currencies in the long term.”

Currencies can frequently deviate from purchasing power parity (PPP) over time, he said. “What should be apparent, however, is the movement in the exchange rate following these events. In almost all cases, the exchange rate moved back to a value that would be regarded as fair when judged according to PPP.

“That is not to say that currencies do not stay cheap or expensive for long periods of time. Idiosyncratic events may cause currencies to deviate from fair value for extended periods; however, currencies tend to move back to levels reflective of inflation differentials in the long term.”

Read: Reserve Bank warns of ‘price spiral’ in South Africa

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