Just how weak can the rand get?
Caught between powerful global and domestic cross-currents, the SA rand faces a volatile year
Predicting the future value of the SA rand is a mug’s game in which those who forecast it with anything approaching conviction are typically the ones least likely to get it right.
So pity currency strategists John Cairns of Rand Merchant Bank and Mike Keenan of Barclays Africa whose job it is to tell us in January where they think the rand will end up by December.
Cairns expects the rand to gain slightly over the course of the year against the US dollar. This is because it’s undervalued and historically the rand has always eventually reverted to its fair value; the SA economy is slowly re-balancing; and global forecasts are that capital inflows into emerging markets will remain strong, US rate hikes notwithstanding.
But he cautions that any gains will be mild since the SA economy needs a weak currency and the current account deficit, though narrowing, still remains large. As such, RMB’s forecast is for the unit to end the year at R11/$ as opposed to R11,56/$ now. Cairns puts the rand’s fair value at R10/$.
Keenan is far less sanguine about what the year may hold for the rand. “Yes, the rand is undervalued and there will be some mean reversion over time,” he agrees. “That’ll help restrict greater depreciation but it can’t prevent it altogether; the global factors driving the rand are stronger.”
The big event Keenan, and indeed all market players, will be watching this year is the moment when the Fed starts hiking interest rates. “When it does it will hurt emerging market (EM) currencies again because there’s still a lot of money directed at EMs despite the periodic sell-offs since the May 2013 taper tantrum,” he says.
Barclays Africa expects the first Fed hike to be in June and, though its official view is that the rand will peak at R11,80/$ this year, Keenan feels there’s a growing risk that it will breach R12/$ when the Fed hikes.
If it does, he expects the rand to remain above R12/$ in the second half of the year with a weakening bias given the lack of any obvious catalyst that could bring about rand strength in the face of the start of a US rate hiking cycle.
“Yes, the start of Fed hiking has been well telegraphed but we fear another disorderly fall-out because investors will wait as long as possible before exiting EMs so as not to underperform their peers,” he says. “The markets are skittish. Capital inflows into EMs have been waning in recent months over growing fears that the Fed will hike and in response to the flagging EM growth environment, relative to the strengthening US economy.”
Cairns is less worried about what will happen to the rand when the Fed hikes. The most important assumption underlying his more benign forecast is that while volatility is likely to accompany changes in the wordings of Fed statements this year, the first hike will be well signalled and will not cause panic.
He feels his “dicier” assumption is that the pace and extent of Fed hikes will not turn out to be worse than the market is expecting.
The collapse in the oil price is creating deflationary pressures everywhere, so there is less pressure on central banks like the US Fed to raise rates and more pressure on the Bank of Japan (BoJ) and the European Central Bank (ECB) to ease policy further to stave off deflation. According to a Reuters poll, the probability of the ECB adopting quantitative easing at this week’s meeting is 70%, rising to 90% by its March meeting.
This should lower bond yields across the board, which would intensify the search for yield and support the rand, he explains. But if the market is wrong and the Fed hikes earlier than June then US yields will likely push higher, which would hurt the rand.
“Our view is that all of this additional stimulus [by the BoJ and ECB] will only partly offset the effect of Fed tightening, but there is still the possibility that the world of 2015 will be seen as having more liquidity, even with the Fed hiking,” says Cairns.
THE ALBATROSS AROUND THE RAND’S NECK, THE CURRENT ACCOUNT DEFICIT, REMAINS UNRESOLVED