Rand close to breaking R17 to the dollar – but needs a bigger push

The rand has strengthened in South Africa, but it is unlikely to break the R17/$ mark without any significant push.

The rand strengthened quickly over the last couple of weeks after the US Federal Reserve cut interest rates by 50 basis points. Higher US interest rates can hurt the rand as investors are drawn to the high and stable returns offered by the world’s largest economy, which impacts emerging markets.

The rand had already appreciated, even if slowly, following the national election in South Africa at the end of May.

The rand reached R17.03/$ on Friday but has been unable to break the R17.00/$ dollar threshold.

“The rand is beginning to unwind its depreciation experienced under the US interest rate hike cycle, with the domestic currency running below R15.00/USD before the US started hiking interest rates in early 2022,” said Investec Chief Economist Annabel Bishop.

“R17.00/$ is a major resistance level, however, with the rand not having reached it yet, and will likely require further momentum to convincingly pierce it, driven either by positive data outcomes, or further US interest rate cut surprises, or both.”

She added that the Chinese stimulus has helped allay some worries over the weakness of global activity, with commodities’ prices seeing some benefit alongside emerging market currencies.

That said, the recent US interest rate cut is the main driver of the rand’s strength.

In South Africa, improving economic activity has had a positive effect on the local currency and reduced political risk following the formation of the centrist Government of National Unity (GNU).

There has also been an increased appetite for South African portfolio assets.

“The substantial movement in the rand since the US interest rate cut this month has brought it towards R17.70/$ more quickly than a 25 basis points US cut would have done, and Q4.24 is therefore likely to be significantly stronger, at R17.20/USD than Q3.24,” said Bishop.

“While the rand is expected to see further strength over the course of the US interest rate cut cycle, markets expect US rate cuts to end in H2.25 and are also eyeing the possibility of further 50 basis point cuts in the US interest rate cutting cycle.”

That said, the fast US interest rate cut cycle currently being factored in by the US tilts the risk towards a faster appreciation in the domestic currency than in the base case. This could, in turn, benefit inflation outcomes.

Bishop added that the recalibration in financial market expectations after the US Federal Reserve’s meeting on 18 September has been the critical driver of rand strength alongside the US rate cut.

The interest rate differential between South Africa and the USA widened by 25 basis points, with the South African Reserve Bank deciding to cut rates by only 25 basis points when it met a day after the US Federal Reserve.

The US is expected to cut again in November and December, while the SARB’s Monetary Policy Committee (MPC) will only meet only once more this year.

Thus, the differential between the USA and South African interest rates is likely to widen by at least another 25 basis points by the end of the year, which should support further rand strength.

“Financial markets expect a cut in US interest rates at every FOMC meeting in the remainder of this year, and over H1.25, a total of six meetings, while South Africa only has four in the period,” said Bishop.

According to the Forward Rate Agreement (FRA) curve, the US is expected to cut its interest rates by around 1.50% (150 basis points) by the end of 2025, while South Africa is expected to see further cuts of 1.25% (125 basis points) at most.

“The further widening in the interest rate differential between the US and South Africa is also supportive of further, marked rand strength, although domestic and global risks (particularly on the geopolitical front) could slow the rand’s trajectory,” added Bishop.

“While load shedding has halted due to increased capacity, lower unplanned outages (by -9% y/y), and lower expenditure on diesel to fire generators (R11.3 billion lower y/y), concerns persist about the stability of the grid, particularly due to aged infrastructure.”

“Progress on rectifying the problems at the ports and on the rails has been slow, severely limiting economic growth. The Department of Minerals and Energy’s lack of ability to drive large-scale mining exploration and investment also limits this.”

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