Rand loses some of its shine – but there is still room for cautious optimism

The rand continued to lose ground against the major currencies in morning trade on Tuesday (15 June) amid a stronger dollar and concerns about rising Covid-19 cases in South Africa. It comes after three successive weeks of gains which saw it become the top-performing emerging market currency.

Markets are looking towards indication from the US Federal Reserve on the timing of the exit from the current ultra-accommodative monetary policies, Nedbank wrote in a note, with the Federal Reserve interest rate decision expected on Wednesday.

“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,” said Bianca Botes, director at Citadel Global.

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, Citadel said.

In the coming months, treasury and forex specialists will carefully monitor the Federal Reserve’s stance, which will be driven by inflation as well as the labour market, it said.

While the Fed has signalled that tapering down of quantitative easing (QE) is becoming topical, we are still quite a while away from seeing a turnaround in monetary policy, Botes said. This cautious stance by the Fed assisted the rand in gaining momentum.

Commodities

“When comparing commodity cycles with the local currency, the correlation between strong commodity prices and a strong rand cannot be ignored,” said 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.

“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,” said Botes.

“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,” said Botes.

From a technical perspective however, Botes said that the rand could be running out of steam, noting some potential pitfalls, including a 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.

She said that local Covid-19 cases and the consequences of lockdown on the local economy are also detrimental, given the lack of growth and high unemployment South Africa is experiencing.

A partial shift in focus back to local fundamentals would shine the spotlight on the following themes:

  • 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 remains 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.

Morgan Stanley said in a market report on Monday that they are tracking back to alternative currencies. “We believe that most of the positive news in South Africa is in the price and the rand’s risk premium is now one of the lowest across EMFX,” it said.

“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 R15.00 as we approach Q3 and Q4 of 2021,” Botes said.

Nedbank has the rand moving towards R15.30 in Q4, while BNP Paribas forecasts a move towards R14.50 in Q3, and R15.00 in Q4.

“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,” she said.

The rand traded at the following levels against the major currencies on Tuesday:

  • Dollar/Rand: R13.74 (+0.25%)
  • Pound/Rand: R19.40 (+0.23%)
  • Euro/Rand: R16.67 (+0.43%)

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Rand loses some of its shine – but there is still room for cautious optimism