Main drivers of SA’s exchange rate global and not local forces

The market always expects the rand to weaken. The large spread between South African interest rates and US or other developed market interest rates indicates that the market expects the rand to weaken consistently against the dollar and other developed market currencies. On July 18, this difference between South African and US 10-year bond yields was 6.43%.

To put it another way, the rand was expected to weaken against the dollar at the average annual rate of 6.43%, from about R13 to R24 for a dollar delivered in 10 years’ time. A US dollar to be delivered in three months or three years always costs more than a dollar bought today. The difference between the spot and forward rand exchange rate for a dollar is always equal to the difference in interest rates in SA and the US.

Someone who borrows dollars at a lower rate and lends rand at a higher rate, without securing the dollars to be repaid at a rate determined today, must be speculating that the rand will enjoy surprising strength; that it will weaken by less than the difference in interest rates. Or vice versa — if you borrow rand, to lend dollars, without insurance, you would be speculating that the rand will have weakened by more than the difference in interest rates.

What the market expects you to gain in higher rand interest income it expects you to have to give away as the rand weakens. Good luck to any speculator taking on the market.

In 2017, the daily interest spread between a South African government bond and a US Treasury bond of the same 10-year duration has varied from 6.4 to 5.94 percentage points, while the USD/ZAR has varied from R13.20 to R12.42.

Yet while the interest spread, or expected exchange rate, has had a narrow range, the two series move together. A stronger rand leads to less rand weakness expected (less of a spread) and vice versa. Another way of putting this point is that the weaker the rand the more it is expected to weaken and vice versa when the rand strengthens. It would seemingly take an extended period of rand strength to improve the outlook for the rand, as was the case from 2003 to 2006 when the 10-year spread narrowed to about 2% with significant rand strength.

The reality is that the behaviour of the USD/ZAR exchange rate has had much less to do with South African events and much more to do with global forces. And such global forces affect the exchange value of the rand and other emerging market currencies in similar ways.

The USD/ZAR exchange rate moves closely in line with those of other emerging market currencies. Dollar strength versus the euro and other major currencies is strongly associated with emerging market exchange rate weakness generally and also USD/ZAR weakness. The correlation since 2012 of daily exchange rates between the USD/ZAR and the trade-weighted dollar index is a very high 0.89.

THE REALITY IS THE VALUE OF THE RAND HAS NOT BEEN MUCH INFLUENCED BY EVENTS IN SA — EVEN OF THE ZUMA VARIETY

Dollar strength after 2014 was closely associated with emerging market and rand weakness. Since June 2017, it is shown how a small degree of US dollar weakness has been associated with emerging market currency and rand strength. Thus betting against the rand at current rates is mostly a bet on the value of the dollar versus the euro and other developed market currencies.

The reality is that the value of the rand has not been much influenced by events in SA — even of the Zuma variety. Relatively slower US growth and a more dovish Federal Reserve could be helpful to emerging market exchange rates (like the rand) over the next few months. The unexpected can happen.