Johannesburg-based Investec says the South African Rand’s recent strong showing against G10 majors is expected to persist this week and could extend across the remainder of 2024.
In a note to investors, forex analysts at the commercial lender and investment bank said a number of ZAR supporting factors are factors falling into line, chief amongst them the slower pace of interest rate cuts from the South African central bank versus the Federal Reserve.
Investec analyzed money market pricing and determined that an additional 50 basis points of rate cuts will likely be delivered by the South African Reserve Bank (SARB) this year, with another 100 Bps likely in 2025. This diverges from the cumulative 250 basis points of cuts expected from the Fed.
Falling interest rates in the US can sometimes give global economic sentiment a boost, ading wind to the sails of the pro-cyclical Rand.
'The risk-off sentiment that prevailed in global financial markets is expected to moderate this week and into Q4 as the first American interest rate cut since 2019 is anticipated later this week,’ Investec wrote. ‘This is in sharp contrast to the steady advance in the Fed Funds rate, which was 5.25 per cent from 2022 to 2023.
Other factors supportive of Rand include improved economic growth in South Africa and a return of stability in power supply. The country experienced zero no load shedding in Q2 2024, and the utilities sector expects that to remain the case for the next few months.
Investec also noted a turn in sentiment towards South Africa after its recent national elections and the formation of a coalition government. 'This has had a stabilizing influence on ZAR, with international investors buying ZAR 18.5 billion in South African government bonds since the election.’
Back in February 2024, ZAR reached a twelve-month high of 17.8 against the US Dollar with analysts at Commerzbank saying there was more at play than the wholesale selloff of USD that was happening at the time.
In fact, while USD/ZAR was scaling new heights, the Dollar had also been recovering against bigger G10 peers, as evidenced by the exchange rates for EUR/USD and GBP/USD. In a market analysis published this week, Commerzbank’s forex strategy unit said the Rand’s outperformance was being influenced by local factors.
The bank’s analysts wrote that the high against USD was down to better-than-anticipated producer prices, which fell to an annualized rate of 4.1 per cent in July, down from 4.5 per cent in June.
‘On average, we were expecting a drop to 4.4 per cent. This marks another upbeat signal for the South African Reserve Bank, which could provide the leeway to cut interest rates in the Autumn, perhaps as early as this month.’
Normally, a looming interest rate cut would weigh on a fiat currency. But there are scenarios where it can be supportive, which Commerzbank says is now the case with ZAR.
'Rate cuts are typically associated with a softening currency. However, South Africa’s disinflation isn’t being caused by a weakening of demand. Rather it's because of structural improvements on the supply side’.
Analysts noted that the country seemed to be free of the power rationing that occurred across much of 2023, marking a period of stability for essential infrastructure.
‘Disinflation is therefore opening the door for interest rate cuts, which could spur more investment and continued structural improvements.’
Taken together these developments lower the risk premium that FX traders had placed on South Africa in recent years, giving the Rand a boost.
In February 2024, forex traders were also weighing their ZAR bets on worries that a coalition government might form after the country’s national elections.
Polls suggested that a coalition government was in the offing, which might have kicked off a period of political uncertainty. Unsettled traders cooled on the Rand as a result, leaving ZAR undervalued.
A previous report from Investec said speculation about potential outcomes and no clear lead for any political in recent polling, had been broadly negative for the Rand.
‘A sense of coming political turmoil has grown steadily this year in advance of the national elections, as the major parties aim to fire up their respective voter bases for support,’ says the report. 'Polls have differed widely, with swings for and then against each party as election day inches closer.’
Macro drivers were also impacting ZAR’s prospects. Compared to other emerging market currencies, Rand had struggled in the early months of 2024 against headwinds caused by dimming expectations for interest rate cuts by the US Fed. The knock-on effects of recent Fed policy signals suggest that the cost of money around the world won't fall as quickly as consensus had expected.
This hindered the potential for global economic growth, and growth-sensitive currencies like ZAR felt the pinch first.
While big picture issues were influencing performance, Investec said the Rand's undervaluation was also being driven by domestic factors and worries that smaller left-wing parties could distract any future government’s policy objectives away from market-friendly fundamentals.
This growing uncertainty had chilled demand for the country’s currency.
‘Political instability is having a predictably negative effect, with support for the ruling ANC in steady decline and a new political landscape emerging.’ Uncertainty about what the future composition of government will be is having a chilling effect on forex traders.
In November 2022, Rand was one of the G20 grouping’s worst performers while G10 major Sterling was near the top. The divergence drove a 12 per cent rally for GBP/ZAR from lows seen in late September of that year, erasing most of 2022’s earlier losses for the pair.
The period of underperformance for Rand happened during another strong month for the US Dollar and a period of abnormal weakness for China's Renminbi. Rand’s descent may have also been aggravated by domestic data that showed manufacturing to be the only sector bright spot in an otherwise slowing South African economy.
