Rand still riding high but risks still close

Although the South African rand strengthened by a significant 7.9% over the past year, real risks of sudden devaluation remain close as unpredictable global factors, such as the Middle East conflict’s effect on oil prices and the US election results, loom large.

Bianca Botes, director and currency expert at Citadel Global, says the rand strengthened on the back of South Africa’s peaceful election transition, interest rate cuts, favourable trade dynamics and suspended load shedding.

However, she warns, the rand could still be affected negatively before the end of the year if the escalating regional conflict in the Middle East affects oil prices, as well as the US elections results, any sudden changes in US monetary policy or interest rate forecasts and a weakening Chinese economy.

“We are keeping a close eye on the conflict in the Middle East and its potential escalation. An escalation in the conflict will cause a global flight to ‘safe haven’ assets but also increase oil prices. While the conflict is largely priced in, you must remain wary of a situation where other countries become involved and the conflict spreads to a wider part of the region.

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Possible impact of US election on rand

“The US election result could also be a defining moment for the market over the next four years. If Donald Trump wins, we could see increased tariffs on exports to the US with a key focus on China, as well as governmental unpredictability and an increase in geopolitical tension and fragmentation. This scenario will again support a case for investors shifting towards safe haven developed market assets.”

Botes says China was an important market to watch to assess potential impact on the rand. “China is the biggest consumer of commodities and the world’s second-largest economy. South Africa is a major exporter of commodities to China and therefore a strong Chinese economy bodes well for the rand.

“It was therefore good news for South Africa when China recently unleashed a much-anticipated stimulus package to the tune of $142 billion, as part of its commitment to reach its 5% growth target. The stimulus package came as a welcome boost for sentiment and commodity prices, which in turn boosted the rand.”

However, she warns, the optimism ran out of steam, as investors started looking towards structural and policy reforms that would ensure sustained foreign investment and confidence in the Chinese economy. “Continuous weak growth from China, weighing on commodity prices, therefore remains a major risk factor for the rand.”

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Stability of GNU another factor for the rand

Botes says another factor that could affect the strong rand is the stability of the country’s new Government of National Unity (GNU). “We are seeing improved sentiment towards South Africa and this will persist if we see some tangible policy reform.

“But bear in mind that policy has a lagging effect and therefore we will only see the economic fruits months down the line although it remains a positive development, even if you do not see growth trending upwards immediately. What we do not want to see happening is a breakdown of cooperation within the GNU.”

She says it is also important to keep an eye on the upcoming Medium Term Budget Policy Statement (MTBPS) on 30 October.

“While we are relatively optimistic about the rand, a word of caution is prudent, while the market is still betting on larger rate cuts than what the US Federal Reserve guidance indicates and disappointment from the Fed can cause a reversal in rand strength, as we have seen over the past week when the rand weakened, as data from the US supported a more hawkish approach by the Fed.”

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Dollar persistently strong over past two years

Botes points out that the dollar was persistently strong over the past two years. “As a result, we have seen the rand and its peers come under pressure against the greenback. We have also seen emerging market currencies as a whole trade in a bear market for about a decade now. 

“These two points are important when we look at the local currency, as when compared to its peers, it is not an exception to the norm. However, that changed over the past few weeks, as we saw the rand continuously outperform most of the other emerging market currencies.”

The rand remains one of only five emerging market (EM) currencies out of a total of 23 that has been trading stronger against the dollar year to date, having ranked third on the list last month and over the course of the past year strengthened by a significant 7.9%, Botes says.

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What contributed to stronger rand?

Factors that contributed to the strengthening of the rand against both its peers and the dollar included improved terms of trade, peaceful elections and the easing of monetary policy. “With gold, which is our biggest export and oil, which is our biggest import, we were seeing a big divergence in price action and the terms of trade have significantly improved for South Africa, with a 43% gain for gold over the past year versus a 17% decline in oil,” she says.

“While we believe that the fair value of the rand is closer to the R17.50/R17.80 range and anticipate volatility in the rand as an array of events unfold, the overall view is that emerging market assets remain well-positioned for a strong rally as the dollar weakens on the back of looser monetary policy.

“For the time being, the Rand is considered overbought closer to R17.00 and profit-taking and technical corrections are expected at this level.”