RESURGENT RANDELA
A weaker dollar and raging commodity prices have driven the rand back to pre-pandemic levels. As long as these trends persist, and the global recovery remains intact, it should hang onto its gains
fter a dismal January in which the rand was one of the worst-performing emerging-market currencies, the unit has gone on a tear, prompting many economists to revise up their 2021 forecasts.
Still, expect typical rand volatility as sentiment veers between fear of the pandemic’s resurgence and hope of a strengthening global recovery.
Internationally, the rand is being supported by a recovery in global risk appetite, combined with renewed dollar weakness, as well as firmer commodity prices. Booming Chinese growth and improving global demand have helped drive up the prices of copper, tin and iron ore, which SA companies mine and for which they earn billions in foreign currency.
The rand is also being buoyed by SA’s improved fiscal backdrop and higher foreign exchange forward yields in response to dollar inflows from the International Monetary Fund (IMF) and New Development Bank (NDB) loans.
In January 2020, before the onset of the pandemic caused a seismic retraction in global risk appetite, the rand was trading at R14/$.
By mid-April, after Moody’s had compounded the country’s misery by junking its credit ratings, it had fallen to a record low of R19.04/$.
However, by the end of October 2020, as SA emerged from the first wave of the pandemic, the rand had strengthened back to R16.24/$.
A surge in commodity prices caused it to rally further over the final quarter to end the year almost back where it started, at R14.60/$.
After hovering around the R15/$ mark in the first quarter of this year, the rand flirted with R14/$ recently, taking its gains to 23% year on year (as of April 20) while emerging-market currencies are up only about 7% year on year.
A stronger rand has helped subdue the impact of rising oil prices, to the point where the petrol price will now drop 13c/l in May, and diesel by 32c/l.
So not only does a firmer rand free up South Africans’ disposable income, it also curbs imported inflation, helping to keep interest rates lower for longer.
Much hinges on continued commodity
Aprice strength, but Rand Merchant Bank (RMB) expects prices to keep rising through 2021, albeit at a more muted pace, sustained by strong credit growth out of China and recovering global demand.
Kim Silberman, fixed income and currency analyst at RMB, now expects the rand to end 2021 at R15.17/$ (previously
R15.30) and to end 2022 at R15.30/$ (previously R15.71).
However, the rand’s trading range is likely to be as wide as ever.
“It can trade down to R14.30/$ during risk-on periods, such as we are experiencing currently, and sell off to R16.50/$ if we experience another risk-off event,” says
Silberman.
Factors that would drive rand moves stronger towards R14.30/$ could include faster vaccine rollouts, stimulatory policy or better-thanexpected economic data in developed markets, any further pick-up in commodity prices, dollar flows into SA, better-than-expected domestic growth and/or inflation data (the consumer price index remaining closer to 3% than 4%), and progress with regard to Eskom.
However, recurrent bouts of nervousness over the path of the pandemic and global
What it means: Expect typical rand volatility as sentiment veers between fear of the pandemic’s resurgence and hope of a strengthening global recovery
RMB’s evolving fair value estimates for the the rand
growth, as well as weaker-than-expected domestic growth and/or higher inflation would drive the rand weaker towards R16.50/$.
Apart from commodity prices, Silberman also attributes the rand’s outperformance to the fact that dollar inflows from the $5.3bn IMF and the two $1bn NDB loans have resulted in an uptick in the rand swap basis (the implied foreign exchange swap rate versus the Johannesburg Interbank Average Rate — the benchmark money market rate used in SA).
“From a currency perspective, this is equivalent to about a 100 basis point [BPS] hike in the repo rate,” says Silberman. In other words, “the cost of shorting the rand is currently around 100BPS higher than it should be”.
Historically, the proceeds of hard-currency bonds have remained offshore and not been converted into rands. However, when the IMF and the first NDB loan proceeds were deposited at the Reserve Bank in July last year, the Bank chose to keep these dollars on its balance sheet.
This required it to create rands when it transferred the funds to the National Treasury — money creation that then had to be sterilised, explains Silberman. The Bank has done this through foreign exchange swaps (purchasing rands in the forward market from domestic banks in exchange for dollars).
This has created a surplus of dollars among local banks which has elevated the rand swap basis and continues to be highly supportive of the rand.
Those loans only need to be repaid in
July 2023.
Ultimately, says Silberman, “this should keep the rand trading stronger and in a tighter range than has been the case since Nenegate”.
Absa currency strategist Mike Keenan has also become much more constructive on the rand, thanks to renewed dollar weakness and firmer commodity prices. He now expects it to end the year at R15.25/$ (previously R16.25/$) and 2022 at R16.45/$ (previously R17.30/$).
In the US, President Joe Biden’s fiscal stimulus package and rapid vaccine rollout plan have caused growth and inflation expectations to rise. But thanks to the US Federal Reserve’s persistently accommodative monetary policy stance, the dollar has weakened this year.
After the Fed cut rates by 150BPS in March last year, the real policy rate differential between the US and the EU dropped from +1.3% in February to –0.4% in April. This widening interest rate differential has weighed on the dollar and spurred demand for risky emerging-market assets, including the rand.
However, the going, for now, might be as good as it gets.
“We think that the rand has become overbought relative to its high-yielding and commodity-based currency peers,” says Keenan. “The trade-weighted rand is also now overvalued on a purchasing power parity basis, while the dollar is undervalued according to this metric.”
Moreover, any hint of higher rates in developed markets could cause a reversal in risk appetite, while any sense that the global recovery is faltering could weaken commodity prices. Both would send the rand tumbling anew.
“We expect global markets to remain volatile over the next six months as sentiment vacillates between Covid fears, vaccine hopes and stimulus-driven reflation,” says Silberman.
Keenan considers the outcome of the public sector wage talks and the potential for rating downgrades to be the biggest domestic event risks this year.
Moody’s is scheduled to review SA’s ratings on May 7. It need not make any announcement on this date, but if it does downgrade SA’s foreign currency rating by another notch it would move to a par with S&P Global Ratings and Fitch. Both have SA pegged on “BB–” three notches down into junk status.
SA’s outlook with S&P is “stable”, but Fitch and Moody’s have SA on a “negative” outlook — which means their next rating moves will likely be downwards. In that event the rand would likely experience a sharp sell-off.
Investec chief economist Annabel Bishop also expects SA’s rising debts and the risk of further downgrades to keep pressure on the rand. She has not changed her forecast for the currency to average R15.20/$ in the fourth quarter of 2021 and R15.60/$ in the fourth quarter of 2022.
But she’s slightly more optimistic that SA will retain its “BB” credit rating with Moody’s, while risk sentiment stabilises and then improves on “sufficient” global and domestic policy support.
However, she still attaches a 44% probability to a gloomier scenario, in which SA fails to stabilise its debt projections and its sovereign credit rating falls into the highly speculative category of single “B” countries with all three major rating agencies.
In this event, she expects the rand to weaken to R16.60/$ by the final quarter of 2021 (previously R17.50/$) and to R17/$ by the end of 2022 (previously R19/$).
TreasuryONE currency strategist Andre Cilliers expects the rand to trade in a R14-R15/$ band (previously R14.25-R16.50/$) this year, moving gradually weaker at the year-end.
He believes the rand’s positive momentum should persist as long as the global mood remains upbeat, while SA’s terms of trade remain favourable and the dollar continues on its weakening path. However, he says, the pandemic and the weak state of SA’s public finances pose ongoing risks.
This should keep the rand trading stronger and in a tighter range than has been the case since Nenegate
Kim Silberman