The rand has strengthened against the US dollar quite significantly since finance minister Enoch Godongwana delivered his medium-term budget speech last week – and more good news may be in store.
The local unit has been given a solid boost in markets thanks to some semblance of credibility to National Treasury’s plans to work South Africa out of its widening budget hole, as well as a softer dollar after the US Fed held on rates.
“The volatile domestic currency has appreciated by over 5% month-on-month,” Investec noted.
“Financial conditions have tightened significantly in recent months, driven by higher longer-term
bond yields, among other factor. This tightening of financial conditions adds to the expectations that the US has seen its last interest rate hike, weighing on the greenback.
As a result, the rand has benefited as foreign investors turn to riskier assets.
The rand closed Friday, 3 November at R18.26/$ and has stayed around these levels on Monday, 6 November – far better than the R19.39/$ a month ago. According to Investec, things could get even better.
“The global risk-on period, which tends to run from November to May, has also benefited the rand, which is expected to pierce the R18.00/$ level and run below it next year,” Investec Chief Economist Annabel Bishop said.
“The markets have brought forward expectations of a US interest rate cut again, with a 25bp drop in the fed funds rate still signalled for midyear, but the chances of rate cuts are growing into earlier periods– but not fully factored in there yet.”
Amidst a challenging market, the Fed has paused the interest rate hiking cycle. As it takes two to three quarters to understand the effect that interest rate hikes have on inflation, the Fed can wait.
Markets are now expecting four 25 basis point cuts in the US interest rates during 2024, increasing risk-taking, and the year-to-date carry trade becoming positive for the rand.
With the decrease in safe investment flows, foreigners also became net purchasers of South African bonds – with R2.8 billion on Friday following a net sell-off the week prior.
“While the year has been volatile for foreign purchases and sales of SA bonds, the (settled Bloomberg, JSE) data shows overall a modest net R7.8 billion in purchases has been made to date for 2023, which can quickly be reversed at such a low amount,” Bishop said.
“However, we don’t think this will necessarily be the case, and foreign interest, while tentative currently, should strengthen for SA portfolio assets, particularly over year-end and the first half of 2024, seeing the rand reach towards R17.50/USD.”
The rand may also strengthen once a US interest rate cut cycle begins, but the market’s recent enthusiasm for US rate cuts has likely run quite quickly.
While having the rand recover further may be on the cards for South Africa, given the multitude of risk factors to take into account, there are also scenarios where things get worse.
Investec’s modelling of five main scenarios has a baseline assumption that the currency will gradually strengthen, heading towards R17.70 by mid-2024.
That means seeing 2023 end out averaging R18.65 to the dollar over the third quarter. The group places a 47% probability on this outcome.
The upside scenarios could see an even stronger performance, pushing to R17.00 or below in 2024 – or even as low as R15.50 in the extreme case – but the conditions for this to take place are unlikely ever become a reality.
Such a scenario would require South Africa to see a surge in economic growth, mass reforms in governance, rapid upgrades to its credit rating, and getting off the greylist as soon as possible. Given the economic realities of the country, these criteria are unattainable, hence the 1% probability attached.
Worryingly, the risks to the downside are more likely.
With a 43% probability, chances of the rand deteriorating further to around R20 to the dollar by mid-2024 are relatively high. A severe downside case (8%) – where the country all but collapses, sparking civil unrest and pushing further into a debt trap – would see the local unit crumble.