Even if load shedding stops, outlook for Rand remains grim

The last two weeks saw the Rand weakening suddenly, from R15.80 to above R16.80 per dollar. It was still trading at around R14.50 in March/April.

Commentators quickly blamed the escalating power interruptions and the expected impact on the economy for the Rand’s blues.

However, Bianca Botes, director at Citadel Global, says that although load shedding negatively affects economic growth and sentiment, the weak performance of the Rand stems from numerous factors.

“Eskom simply switching the lights back on will not result in a significant rebound,” she says.

Botes says that the global economic environment and a change in risk appetite are some of the factors that have been contributing to the sharp drop in the Rand’s value.

“The Rand has been affected by geopolitical events such as the Russia/Ukraine war, as well as the increase in inflation around the world and interest rate hikes.

“Central banks around the world are looking to rein in inflation to prevent the significant economic damage that comes with long-term higher levels of inflation.

“This is why interest rates are watched so closely,” she says.

Global forces

Izak Odendaal, investment strategist at Old Mutual Wealth, notes that sentiment turned against the Rand over the past few days as the implications of Stage 6 load shedding sank in, but “for the most part, the currency has responded to global forces”.

Until recently, the Rand has been supported by elevated commodity prices, but recent dollar strength has exerted downward pressure, he says.

Botes adds that investors around the world have been flocking to the strong dollar. “The dollar has surged to a 20-year high against the euro and is now investors’ ‘safe haven’ asset of choice.

“Emerging market currencies, including the Rand, will therefore feel the pinch of the rising dollar,” she says.

Recession risk

Then there is the risk of a global recession.

“Taking a lesson from history, one can conclude that a recession is almost always preceded by a period of tightening monetary policy [rising interest rates, for example] and fiscal contraction [less government spending, higher taxes, or both] and often higher energy prices,” says Botes.

“The increasing risk of a recession is dampening appetite for risk assets, such as the Rand and other emerging market currencies, and assets denominated in these currencies.

During times of low sentiment, high risk and economic uncertainty, investors are flocking to safe-haven assets.”

Unfortunately for gold bulls, the yellow metal is not popular as a safe haven right now and is not as attractive to investors due to the surge in interest rates and high yields offered by US bonds.

ALSO READ: Renewed concern: Food prices adding to burden of higher fuel rates

Strong dollar

Walid Koudmani, chief market analyst at financial brokerage XTB, says the dollar reached its highest level against the euro since December 2002 amid a significant boost in demand for dollars.

“The move not only pushed the exchange rate below the lows of May 2022, but also below the lows from the turn of 2016 and 2017, meaning that [the] euro/dollar traded at the lowest level in almost 20 years,” he says.

“While the greenback strength is currently playing a role in the major move, as it trades higher against most currencies, the euro continues to struggle as the European Central Bank [ECB] has been behind other central banks with its policies.

“There has been an increasing divergence between the ECB and the US Federal Reserve, which has managed to aggressively increase interest rates lately in an effort to tackle inflation,” adds Koudmani.

“The European counterpart has had to be more passive, as it remains wary of the real dangers of slowing the economy in a time where the Russia/Ukraine conflict is causing a spike in energy prices and general inflation.

“The ECB is caught between a rock and a hard place, as it needs to raise interest rates to tackle inflation and boost its currency while simultaneously supporting struggling economies which are just recovering after two years of pandemic-related issues.”

Shaun Murison, senior market analyst at IG, says the last few days have been “one-way traffic for the Rand”.

He also points out that while load shedding has soured business and investor sentiment on the domestic currency, the primary influence on the rand remains from the international front, particularly the surge in the dollar.

Dollar indexed against developed market currencies

Murison says it seems the Rand is set to remain weak. When the exchange rate breached R16 per dollar, the next hurdle was R16.20, but it ran past that quickly.

DailyFX remarks that the Dollar increased to its best levels since late 2012 compared with a basket of currencies, supported by high-interest rates in the US.

“Since mid-June, US treasury yields have repriced lower on the assumption that the US central bank would blink and pivot to prevent a significant economic downturn.

However, the Fed has not given any indications that it intends to step on the brakes; on the contrary, policymakers have signalled that they will press ahead with their plans to remove policy accommodation aggressively in their effort to restore price stability,” says the market commentator.

“Despite the ongoing headwinds, macro-related data have held up well, particularly from the labour market.

“The June non-farm payroll report showed a net gain of 372 000 jobs, well above consensus expectations of a 268 000 increase, a sign that hiring conditions remain solid.

“In the current environment, the US dollar is likely to maintain a bullish bias,” according to the DailyFX forecast.

Inflation

As long as SA’s inflation rate remains at levels significantly higher than those of its main trading partners, the rand will continue to weaken with little hope of strengthening by much – even if the dollar gives up some of its recent sharp gains.

Adriaan Pask, chief investment officer at PSG Wealth, says the increase in SA’s inflation rate to a five-year high of 6.5% in May indicates that inflation will remain high.

“The Reserve Bank forecast of headline inflation for 2022 was revised higher, to 5.9% from the previous 5.8%, due to higher food and fuel prices. Prices continued to accelerate mostly for transport (15.7%), food and non-alcoholic beverages (7.6%) and housing and utilities (4.9%),” says Pask.

“While food prices are expected to remain elevated, fuel price inflation should ease in 2023, helping headline inflation to ease to 5%, despite higher core inflation.”

Inflation has been increasing worldwide, forcing central banks to accelerate their normalisation of global policy rates. “On balance, capital flow and market volatility are expected to remain for emerging market assets and currencies,” says Pask.

This article first appeared on Moneyweb and was republished with permission. Read the original article here.