The big issue hitting the rand and interest rates in South Africa – and it’s not the elections

South Africa’s rand is highly dependent on the decisions of the US Federal Reserve, and domestic issues, such as election polls, are often dwarfed by changing sentiments regarding the US central bank.

The US dollar is the global currency reserve, so all financial assets worldwide price the Fed’s policy interest rate, as the US financial markets dwarf all others.

Old Mutual Wealth Investment Strategist Izak Odendaal said that the Fed, in turn, makes decisions based on achieving two objectives: stable prices and maximum employment.

The inflation target is set at 2%, while the employment goal is ideally in the range of 3.5% to 4.5%.

“Above that, there are people who want to work but can’t find jobs; below that, there is a shortage of workers, and an overheating economy. This, in turn, could undermine the inflation goal,” said Odendaal.

Not all central banks have an explicit dual mandate. The South African Reserve Bank’s mandate is stable inflation, with a target range of between 3% and 6%.

“When it comes to South Africa, there is no question that the Fed looms large in the Reserve Bank’s thinking,” said Odendaal.

“The US inflation numbers interrupted a promising little rally in the rand last week – it wasn’t because of pre-election polls as some headlines claimed.”

“As the timing and depth of US interest rate cuts gets pushed back, the same is probably also true for local rates. In fact, the local money market is no longer pricing in any rate cuts this year, though such a view is probably overdone.”

Bets in the financial futures market predicted that the SARB won’t cut interest rates in 2024 amid persistent inflation, with investors even pricing in a hike from the domestic central bank next month due to changing sentiment over the US Fed.

South Africa’s advantage

However, Odendaal said that the big emerging market crises of the past few decades, particularly in the 1980s and 1990s, were caused by Fed cycles.

Although debt defaults have occurred in Sri Lanka, Ghana, Zambia and Argentina, there has been no widespread emerging market contagion.

Many emerging markets have adopted floating exchange rates, which are built on foreign exchange reserves and reduced foreign borrowing.

Some emerging markets, such as Brazil, Chile and Hungary, increased rates before the US Fed in 2022.

These countries are now able to cut rates as domestic inflation is tamed, even if the Fed has yet to cut.

“As they cut, South Africa’s short-term interest rates no longer seem relatively low in the peer group, and that should take some pressure off the rand,” said Odendall.

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