Rand could be heading for trouble

 ·8 Oct 2024

The South African rand has strengthened in recent months—but there are real risks of a sudden devaluation.

According to currency expert Bianca Botes, a Director at Citadel Global, the rand strengthened due to South Africa’s peaceful election, interest rate cuts, favourable trade dynamics, and suspended load shedding.

The rand improved by 7.9% from the start of the year to 7 October compared to the US dollar and currently sits at R17.49/$.

That said, factors such as the escalating regional conflict in the Middle East could still negatively impact it before the end of the year. The conflict could also affect oil prices.

Other risks include the United States election results, sudden changes in US monetary policy and a weakening Chinese economy.

International

“We are keeping a close eye on the conflict in the Middle East and its potential escalation. An escalation in the conflict will cause a global flight to ‘safe-haven’ assets and increase oil prices,” said Botes.

“While the conflict is largely priced in, one must remain wary of a situation where other countries become involved and the conflict spreads to a broader part of the region.

“The US election result could also be a defining moment for the market over the next four years. If Donald Trump wins, we could see increased tariffs on exports to the US with a key focus on China, as well as governmental unpredictability and an increase in geopolitical tension and fragmentation.”

“This scenario will again support a case for investors shifting towards safe-haven developed market assets.”

She added that China is an important market to watch to assess the potential impact on the rand.

“China is the biggest consumer of commodities and the world’s second-largest economy. SA is a major exporter of commodities to China, so a strong Chinese economy bodes well for the rand.”

“It was, therefore, good news for South Africa when China recently unleashed a much-anticipated stimulus package to the tune of $142 billion as part of its commitment to reach its 5% growth target.”

“The stimulus package came as a welcome boost for sentiment and commodity prices, which in turn boosted the rand; however, the optimism ran out of steam, as investors started looking towards structural and policy reforms that would ensure sustained foreign investment and confidence in the Chinese economy.”

“Continuous weak growth from China, weighing on commodity prices, therefore remains a major risk factor for the rand.”

In addition, although many are optimistic about the rand, the market is still betting on more significant rate cuts than the US Federal Reserve (Fed) guidance indicates.

Interest rate cuts in America should boost the rand as investors leave the safety of US assets in search of higher returns. The last interest rate decisions saw the Fed cut rates by 50 basis points, while the South African Reserve Bank (SARB) cut rates by 25 basis points.

That said, a Fed disappointment could cause a reversal in rand strength, as seen by the rand dropping from R17.02/$ on Monday, 30 September, to R17.49/$ on Monday, 7 October, after data from the US supported a more hawkish approach by the Fed.

The dollar has been persistently strong for the last two years.

“As a result, we have seen the rand and its peers come under pressure against the greenback. We have also seen emerging market currencies as a whole trade in a bear market for about a decade now.”

“These two points are important when we look at the local currency, as when compared to its peers, it is not an exception to the norm. That, however, changed over the past few weeks, as we saw the rand continuously outperform most of the other emerging market currencies.”

The rand remains one of only five emerging market currencies trading stronger against the dollar this year.

“With gold, which is our biggest export, and oil, which is our biggest import, we were seeing a big divergence in price action, and the terms of trade have significantly improved for SA, with a 43% gain for gold over the past year versus a 17% decline in oil,” said Botes.

Back home

The stability of South Africa’s new Government of National Unity (GNU) could also impact the rand.

“We are seeing improved sentiment towards South Africa – and this will persist if we see some tangible policy reform, bearing in mind policy has a lagging effect, so we will only bear the economic fruits months down the line – but it remains a positive development, even if you do not see growth trending upwards immediately.

“What we don’t want to see happening is a breakdown of cooperation within the GNU.”

Thus, it will be key to pay attention to South Africa’s upcoming Medium Term Budget Policy Statement (MTBPS) towards the end of the month.

Where next

“While we believe that the fair value of the rand is closer to the R17.50/R17.80 range and anticipate volatility in the rand, as an array of events unfold, the overall view is that emerging market assets remain well-positioned for a strong rally as the USD weakens on the back of looser monetary policy.

“For the time being, the rand is considered overbought closer to R17.00 and profit-taking and technical corrections are expected at this level.”

Investec Chief Economist Annabel Bishop expressed similar sentiments, noting that the rand is highly volatile, which reflects investor sentiment.

Bishop said that foreigners are showing changing levels of interest in South African portfolio assets week to week.

“Volatility is likely to persist for the domestic currency, as it remains influenced by US data releases and commentary from monetary policy officials,” said Bishop.

ZAR/USD (Source: Google)

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