Rand set to soar

The rand is set to soar in the coming months as looming rate cuts in the United States push capital towards assets with better real yields, including South African assets. 

Crucially, rate cuts in the United States are unlikely to be matched with a reduction in interest rates from the Reserve Bank. 

While inflation remains low, the bank’s Monetary Policy Committee (MPC) is implicitly targeting 3%, which makes another rate cut unlikely. 

This is despite South Africa’s weak economic growth, with some economists calling for the Reserve Bank to cut rates to boost activity. 

Old Mutual chief economist Johann Els is not one of these economists, as he explained that rate cuts will not solve South Africa’s supply-side issues with electricity and logistics. 

Els does not see any room for the Reserve Bank to cut interest rates as inflation moderately picks up throughout the rest of the year. 

“Under a 4.5% midpoint inflation target, this environment might have supported a cut. However, the Reserve Bank’s current de facto focus on 3% inflation effectively rules this out,” Els said. 

“I, therefore, expect the MPC to keep rates unchanged next week – and likely through to 2027, when a new cutting cycle may begin.” 

In contrast, Els expects the US Federal Reserve to cut interest rates at its next meeting to support a weakening American economy. 

“The Federal Reserve’s focus has shifted toward supporting the real economy. Inflation remains above the 2% target and somewhat sticky, but the labour market has slowed markedly in recent months,” Els said.  

“While employment is still growing, the pace has moderated significantly since the start of the year, pointing to potential weakness in household incomes and spending ahead.”

At its last meeting, two Fed governors voted for a rate cut, indicating a greater push for interest rate reductions in the world’s largest economy. 

“I expect the Fed to deliver a 25bp rate cut next week, followed by a series of similar cuts over the next 4 to 5 meetings. However, there is a material probability — close to 50% — of a 50 basis point move at this meeting,” Els said. 

He even indicated the possibility of a 75-basis-point or 100-basis-point cut. However, this would shock markets and trigger a sharp decline in the dollar, so it is very unlikely. 

An interest rate cut in the United States, followed by the Reserve Bank holding rates, will result in a stronger rand. 

“The result of these moves should see the rand exchange rate gaining some ground – perhaps a lot of ground, depending on the size of the US rate cut,” Els said. 

Rand weaker than fair value

The rand could strengthen meaningfully in the coming months if Els’ scenario plays out, with the dollar having room to weaken and the rand to strengthen. 

During his mid-year macroeconomic update, Els explained that the rand has benefited from a weaker dollar so far in 2025, with it weakening against other major currencies such as the euro and pound.

Typically, a weak dollar is combined with better emerging market growth and stronger currencies in these economies, such as the rand.

Els said he expects the rand to continue strengthening in the short term, with it trading far weaker than its fair value. 

He estimates the rand’s fair value to be at R11.54 to the US dollar, significantly below its current level of R17.40. 

Previously, Els explained to Daily Investor how he uses inflation differentials to calculate the fair value of the rand. 

Using the difference in producer price inflation between the United States and South Africa, Els can derive where the rand should be trading if the inflation rates were the same. 

Els uses this method as the rand will naturally adjust to ensure South African exports are priced competitively around the world in US dollars.

Thus, as local inflation is higher than in the United States, the rand should depreciate by the difference to make the exports competitive.

He said the rand tends to swing between being undervalued and overvalued as it is a relatively volatile currency used as a proxy for investor sentiment towards emerging markets and is buffeted by global forces. 

A currency should always return to its fair value. The only question is when that will happen.

Even according to purchasing power parity, the fair value level of R11.54 does not include the significant risk premium attached to South African assets.

With this risk premium attached, the rand’s value should be between R17.80 and R18 to the US dollar. The risk stems largely from policy uncertainty and the government’s deteriorating finances. 

South Africa’s lacklustre economic growth over the past 15 years also plays a role, with a sustained pick-up in activity likely to translate into a much stronger currency. 

While Els believes this is possible and that the rand will strengthen in the short term, he does not think it can reach its fair value level without sustained economic growth, improved government finances, and substantial upgrades to the country’s credit rating. 

“This cycle is similar to what was seen in 2020 to 2021. During the Covid-19 lockdown, the rand hit R19/USD. It then went from R19/USD in April 2020 to R13.50/USD in June 2021,” Els said. 

“People do not think the rand can trend like that, and it has in the past when the climate was right.” 

Such an extensive gain versus the dollar is often driven by global factors, particularly the US interest rate cycle and the Chinese economy. 

While these two forces appear to be positively impacting the value of the rand, Els does not think they will be enough to bring the currency down to R11.54/USD.