Business

Threat to rand strength

The rand’s recent strengthening has been reversed by the South African Reserve Bank’s indication of potential earlier interest rate cuts despite improving global economic conditions and political stability in South Africa.

Investec chief economist Annabel Bishop said the rand has seen significant strength over recent months.

The rand weakened in 2022 and 2023 as the US hiked its interest rates more quickly, with its monetary policy meeting every six weeks and South Africa’s Monetary Policy Committee (MPC) meeting every two months.

This translated into the US hiking by 50 basis points more than South Africa in total, despite South Africa having started hiking sooner.

The rand weakened from R14.50/USD in early 2022 to R 20.00/USD in 2023 but pulled back towards R18.00/USD at the end of the US rate hike cycle.

Then, the expectation of US interest rate cuts saw the rand near R17.80/USD momentarily.     

However, on 18 July 2024, the MPC had its July meeting and announced that while rates would remain unchanged, its votes were split, indicating a potential cut at its next meeting.

Bishop explained that this announcement reversed the rand’s strength. The domestic currency weakened to R18.37/USD last week and reached R18.33/USD on 22 July, undermined by the SARB’s dovishness. 

She added that the market has also been concerned about the rise in support for former US President Donald Trump to take another term, as expectations have fluctuated on his attempted assassination and President Joe Biden’s decision not to run for re-election.

“Markets worry a Trump presidency would see increased trade restrictions and weaker global GDP growth, negatively affecting South Africa, while uncertainty prevails on foreign and monetary policy, which suppresses risk sentiment,” Bishop explained.

She said a modest lift in risk aversion had seen some strength in the US dollar, and the domestic currency pulled back from below R18.00/USD, with markets also watching US growth and related data. 

“Market participants still see virtually no chance of US interest rate cuts this month, while the same view prevails for South Africa,” she said. 

“However, market expectations for a rate cut have now grown for September in South Africa, weakening the rand.”

Investec chief economist Annabel Bishop

South Africa’s forward rate agreement is now factoring in almost an 80% chance of a 25 basis point interest rate cut at the September MPC meeting and just above a 40% chance of another at the November MPC meeting. 

In the US, close to a 60% chance is now seen of a 25 basis point cut in the fed funds interest rate at the November FOMC meeting, along with a 100% chance of a 25 basis point cut in the fed funds rate in addition in September. 

“This has likely added to South African rate expectations,” Bishop said.

“The dovish market view on interest rates in South Africa has weakened the rand, with market expectations changing over the last few days in South Africa post the MPC meeting, and so providing an underpinning of weakness to the domestic currency.”

However, she said it is not certain these interest rate cuts will occur, as the economic data between then and now, particularly the inflation data, will have a marked influence on the authorities’ interest rate decisions.

However, the Reserve Bank has notably lowered its inflation expectations, a positive sign that it may be comfortable enough to cut interest rates at its next meeting.

“The longer South Africa delays its first interest rate cut, the likely stronger the rand, which is positive for inflation, as rand appreciation is a significant contributing factor to lowering inflation, particularly when international commodity prices are not rising,” Bishop said.

“The ongoing unity overall in the governing of South Africa by the new administration has provided some positive sentiment for the rand which aided it stronger in June and into July, but has not been the main driver.”

She said the driving factor for the rand’s strength over the past few weeks has been the improving outlook for US interest rate cuts.

“However, the shift in South Africa in terms of market expectations to a September cut instead of only one in SA began after the MPC meeting, with the domestic currency at R17.95/USD on Monday but R18.28/USD by Friday,” she said.

So far, the rand has averaged R18.22/USD for the third quarter of 2024. However, with only one month partially completed, the rand is still expected to strengthen into the quarter, but much will depend on the timing of both US and local interest rates. 

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