South Africa’s rand is feeling the love

This month’s most lucrative emerging-market carry trade is attracting foreign investors to South African rand bonds at the fastest pace since January.

Global investors bought a net R23.1 billion of government debt in the first week of August, the largest weekly inflow since January, according to JSE data.

That’s helped traders earn 2.5% in the dollar-funded carry trade so far this month, the most out of 22 developing-nation currencies tracked by Bloomberg.

The renewed interest in South African bonds comes after yields jumped to six-month highs in March as the Iran war drove up oil prices, sparking inflation concerns.

Since then, the 10-year yield has dropped more than 80 basis points to around 8.57% as crude prices have moderated and the rand has strengthened.

Still, it remains well above February’s decade-low of 7.95%, suggesting further gains are in store as the country’s fiscal backdrop improves and inflation moves toward the central bank’s target.

“If we see continued rand appreciation, bonds could price out a lot of upside inflation risks that have come into the price of yields since the rise in oil prices,” said Adam Furlan, a portfolio manager at Ninety One.

“Strong currency performance definitely improves the outlook for local bonds in terms of the feed-through into lower inflation.”

The rand has strengthened 5% against the dollar since the end of March, buoyed by a hawkish central bank that’s seen keeping the currency yield advantage over the dollar in place.

That supports the carry trade, or borrowing one currency cheaply to invest in a higher-yielding asset elsewhere.

Meanwhile, implied volatility for the rand versus the dollar over the next year fell below realised volatility this week for the first time in three years, suggesting options traders see price swings moderating into 2027.

That also bolsters the carry trade, as smaller fluctuations imply less risk of currency weakness eroding returns.

Easing concerns of Federal Reserve interest-rate hikes in the US are also positive for the South African currency, said Ning Sun, senior EM strategist at State Street in Boston.

Traders are pricing in a roughly 50% chance of a quarter-point increase next month, compared with a 68% probability of a similar hike by the South African Reserve Bank.

“The rand is partly carry, partly beneficiary of a weak dollar and dovish Fed,” Sun said. “We have a medium-term bearish view on the dollar, and we think the rand is the best in emerging markets to express that view.”