Perspective on the Rand

thumbs_photoxpress_3160273 - sunset roadEssential Context

Understanding the recent performance of the Rand is the key to gauging its shorter to medium term prospects.

In recent months, global currency traders have been navigating increasingly unsettled waters. Amidst global economic uncertainties, storm warnings for emerging market currencies – which include South Africa – began to appear on radar screens. Curiously, the storm warnings arose because of clear signs of economic recovery in the United States and positive signs in some countries in Europe.

The concern was that as recovery opportunities in these countries became interesting for investors, investor funds would begin to flow out of emerging market economies – where portfolio investors had been finding higher yields during the global recession – and where economic growth was now moderating.

Furthermore, it was likely that, as the US recovery began to strengthen, the US Federal Reserve would begin to phase out the special support measures it had put in place at the height of the global financial crisis. The net effect would be a tightening of liquidity in US financial markets resulting in bond market yields beginning to rise. This would be an additional factor drawing in investment from elsewhere.

The fear was that countries losing portfolio capital had an already weakened underlying balance of payments, meaning that the negative impact on their currencies and their economies could be large. South Africa was one of a group of emerging market economies – known as the “Fragile Five” – Brazil, India, Indonesia, Turkey and South Africa, with such vulnerabilities. In South Africa’s case, vulnerability came from constraints on export performance and high import levels, together with domestic problems which unsettled business and investor confidence and dimmed shorter-term economic recovery prospects.

Performance and Outlook

In recent months, some of these dynamics began playing out in the markets. The Rand together with many other emerging market currencies lost substantial ground against the US dollar. For instance, between mid December 2013 and the end of January 2014 the Rand lost a further 8% of its value against the US dollar. This was however not as much as countries such as Turkey and Argentina – the former slipped nearly 14% against the US dollar, whilst the latter lost close to 23%.

Markets seldom behave in an orderly fashion and currency markets tend to be volatile at times of uncertainty. Market psyche and trading mechanics add amplitude to exchange rate movements. There is a widely held view that the Rand at current values to the US dollar i.e R/US$ 11.06 on 8 February, has a significant element of “overshoot” to the downside and that the currency is likely to recover some of the ground lost over the past year. The question is, how much and over what time scale?

The Reserve Bank’s recent preparedness to raise interest rates to provide relief to the currency is one immediate supporting factor. Another is that economic fundamentals should begin to underpin an appreciation of the Rand in the second half of 2014 – as export markets improve and the domestic economy begins to strengthen. In this regard, Bloomberg reported on 6 February that David Bloom (global head of HSBC currency strategy) saw the R/US dollar at 10.40 by year-end 2014.

In short, it is perhaps wise to anticipate some further weakness in the Rand before it begins to strengthen (based on the market correcting itself as it had likely “overshot”) and on economic fundamentals. But, regarding timing, it is prudent to remember that markets move on expectations and it is possible that positive news might be discounted sooner. In this situation a recovery in the Rand might take place closer to mid-year rather than later in the year. That said, markets don’t like surprises – especially unpleasant ones – so with a general election announced for 7 May 2014,  one obvious risk (to be watched carefully) to a recovery in the Rand is how developments in South African politics will  unfold.

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