Rand hit by bad news for interest rates

The rand was dealt a blow on Monday (5 January), pushing back to R19 against the dollar after markets responded negatively to indications that interest rates would remain higher for longer than anticipated.

The US Federal Reserve has doused hopes for an earlier interest rate cut in the states, with chair Jerome Powell warning against “moving too soon”, before the job of higher interest rates is done.

According to Investec chief economist Annabel Bishop, this has signalled to markets that the first US rate cuts are likely to come in the middle of the year, which has left emerging markets – like South Africa – in the dust.

Financial markets have been reducing the probability of an early interest rate cut in the US as the year has progressed, now down to only a 69% chance of a May. Previously this was seen as a 100% certainty in early January.

Markets saw an 87% chance of a 25bp cut in March, now that has been factored out to a highly unlikely 17%, and markets only see a 100% probability of a US interest rate cut now in June.

“This pushing back of the timing of the first occurrence of the US interest rate cuts in the anticipated cycle has had a marked effect on financial market expectations, and so weakened EM currencies across the board,” Bishop said.

“That is, when US interest rates are cut, EM currencies tend to strengthen substantially, and this can begin before the US cut cycle begins. The rand is one of the currencies in the EM basket which tends to see the most volatility in this regard.”

Specifically, the domestic currency has seen very substantial strength over US interest rate cut cycles, and weakness over hike cycles due to its high liquidity and deep trading markets, with the rand being used as a risk proxy.

For South Africa’s rates, the tone set by the Fed is very much in line with what has been coming out from the South African Reserve Bank.

As such, Bishop said that it is highly unlikely that South Africa will cut its interest rates in March or even May 2024, with the most likely cut coming around just after the US rate in July 2024.

In the meantime, the rand remains very weak, Bishop said, running around the R19.00/USD mark – and easily able to weaken further, far removed from fair value of around R15.00/USD.

Read: The ‘real’ value of the rand in 2024 – according to the Big Mac Index