CAN THE RAND BEAT A BLOWOUT?

The currency is under intense pressure and is likely to suffer extended weakness this year, but it should bounce back strongly as soon as the Fed stops hiking

The rand has got off to a bad start for the year. Nearly all commodity currencies have buckled under the dollar’s strength, but the rand has fared far worse than most, probably due to the crippling impact of load-shedding on the country’s growth outlook.

This raises questions as to how long the rand’s recent underperformance will last, and what the likely implications are for the path of domestic inflation and interest rates.

As ever when it comes to the rand, there is a wide range of views from the doomsday prediction that the currency could slide all the way to R19/$ by the end of the year to a best-case scenario of R15/$ (see graph).

The Bloomberg consensus is for the rand to end 2023 at about R17/$, which would take it roughly back to where it started the year. This would entail some pullback from the current R18/$ level.

The domestic currency has also lost ground against the euro and pound this month, sliding over the R19.30/€ mark (from R18.83/€) and close to R22/£ (from R21.39/£).

On one thing there is broad agreement: the behaviour of the mighty US Federal Reserve and by extension the performance of the dollar is going to be the main driver of rand moves this year.

Over the past week, the emergingmarket currency basket, including the rand, weakened in response to the surprisingly strong January US jobs report and disappointing US inflation data.

US employment growth exceeded expectations with 517,000 jobs created against an expected slowdown to only 185,000. The unemployment rate fell to 3.4%, a level last seen in 1969.

While this may be good for growth, it complicates the conduct of monetary policy because such a tight labour market suggests that inflation is likely to remain sticky.

At the same time, US headline inflation slowed only marginally to 6.4% in January from 6.5% in December against a consensus expectation that it would fall to 6.2%. US core inflation, which excludes food and energy, is slowly rising.

Together, these data releases have forced a reassessment of the pace at which the Fed is likely to temper rate

TAKING A HAMMERING

Commodity currencies versus the US dollar

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-1.7

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-2.9

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-3.6

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-6.4

Hong Kong dollar Chilean peso Turkish lira

Indian rupee Philippine peso Taiwanese dollar Indonesian rupiah Chinese renminbi Bulgarian lev Czech koruna Singapore dollar Romanian leu Argentinian peso Malaysian ringgit Brazilian real Japanese yen Polish zloty

Thai baht

South Korean won South African rand Colombian peso Russian rouble hikes this year. For while inflation may have peaked in the US, resilient economic growth and employment make it hard to believe that inflation will rapidly decline all the way to the Fed’s 2% target and stay there.

Indeed, the process is likely to take “quite a bit of time”, according to Fed chair Jerome Powell.

The Fed futures market is now pricing in a more moderate disinflation path. More US rate hikes are expected in the first half of the year, and fewer cuts towards the end of the year.

The likelihood of rates remaining higher for longer implies that the dollar will remain stronger for longer, keeping the rand under extended pressure this year. (The rand typically moves inversely to the dollar.)

But why has the rand performed so much worse than its commodity currency peers?

Over the year to date, it has weakened by 5.3% against the dollar, making it the third-worst performer

after the Colombian peso at -6.1% and the Russian rouble at -6.9% (see graph).

“Strong tailwinds from China’s reopening are helping commodity-linked currencies such as the Chilean peso, Brazilian real and Australian dollar,” says BNP Paribas economist Jeff Schultz.

“However, the rand continues to underperform its peers due to local factors — a lack of stable electricity supply and faltering freight rail volumes — dampening any positive impetus coming from China’s reopening.”

Other economists have suggested that domestic factors such as South Africa’s potential greylisting over inadequate money-laundering and antiterrorist financing controls, and weak confidence related to the faltering growth outlook may also be weighing on the rand.

“Business sentiment is depressed, damaged also by weakening economic productive capacity as rail and port transport capacity deteriorates, along with security of water supply, and the Reserve Bank revising its GDP growth forecast to close to zero,” says Investec economist Annabel Bishop.

Schultz expects the rand to end 2023 at about R17.50/$, which puts him in the below-consensus camp. He warns of the risk of “persistent weakness” in the currency over the course of the year, driven by a deterioration in South Africa’s current account deficit and a likely widening yield differential between South Africa and its major trading partners.

He notes that not only have South Africa’s freight volumes slid to levels last seen in the early 2000s due to problems at Transnet, but electricity shortages are limiting mining production (down 9% year on year in November), further dampening the outlook for exports.

The upshot, he believes, is that South Africa will post a current account deficit of about 1.6% of GDP this year on faltering export volumes, though it could be even higher if imports are driven up by a surge in renewable energy projects.

This will create a persistent headwind for the rand — something he doesn’t think the market has fully factored in yet.

Absa currency strategist Mike Keenan also expects the rand to exhibit a clear “weakening bias” to end the year at about R18/$ (previously R16.85/$), for much the same reasons.

In addition to an anticipated widening of South Africa’s current account deficit, he also expects Fed hikes to bring down inflation faster in the US than in South Africa, which would widen the inflation and interest rate differential between the two countries. This will make South Africa vulnerable to capital outflows from the bond market, putting pressure on the rand.

“The biggest worry is that the Fed will keep tightening,” says Keenan.

This would certainly create a dilemma for the Reserve Bank, which is approaching the end of its hiking cycle. It will be hard for it to justify moving in lockstep with the Fed to protect the rand while domestic inflationary pressures are subsiding, and the economy is being battered by load-shedding. Even if the rand remains under pressure, the Bank can probably only get away with one more 25-basis-point hike.

On the other hand, Keenan concedes that if the Fed becomes less hawkish over the coming months or commodity prices and risk sentiment remain buoyed by China’s reopening, the rand could weaken by less than he expects.

But this is not his base case. Even though the extent to which the rand has already weakened seems overdone in the short term, he can’t see it going back below R17/$ this year. He thinks the balance of risks is tilted to the rand finishing the year weaker than his year-end prediction of R18/$.

What it means: The rand is headed for a rough year given sticky global inflation and a resilient US dollar, compounded in South Africa by load-shedding and weak growth

At the opposite end of the scale is Momentum Investments. It holds an above-consensus view, forecasting that the rand will average R16.70/$ over the year as a whole, and end the year at 16.20/$. It places the fair value of the rand at R16.40/$.

Momentum economist Sanisha Packirisamy agrees that the rand is unlikely to strengthen on a more sustainable basis until financial markets get a whiff of the pivot in global monetary policy to an easing stance.

She also concedes that the rand could go to R18/$ if the US does indeed slip into recession, as emerging-market assets would react negatively in the ensuing risk-off environment.

However, she expects that as the Fed eases its tightening cycle later in the year, this will lift the dollar boot off the rand’s neck, allowing the domestic currency to strengthen all the way back to the R16/$ handle.

“As markets start to focus on the potential for interest rate cuts towards the end of this year or beginning of 2024, that would likely trigger a risk-on environment in which capital would flow out of the US and into perceived riskier markets that have a higher yield potential,” Packirisamy explains.

“As such, the rand, alongside other emerging-market assets, will likely benefit into the year-end.”

A second key factor underpinning her expectations of a rand recovery is the likelihood that commodity prices will remain elevated thanks mainly to China’s swift lowering of Covid restrictions.

Old Mutual Wealth investment strategist Izak Odendaal is also constructive on the rand, noting that it has historically recovered quickly from severe blowout episodes when global conditions have changed, or the dollar has pulled back.

“The dollar should continue easing this year as the Fed’s rate cycle comes to an end, but of course there are several moving parts,” he says. “The rand’s recovery has been interrupted by loadshedding but it should resume. I think a 16 handle on the exchange rate by yearend is quite possible.”