The rand plummeted – and what to expect next

The United States Federal Reserve (Fed) raised interest rates by 0.75% for the third consecutive time last week to fight record inflation, and the impact is felt across the globe.

The rand weakened to below R18 to the dollar in overnight trading on Sunday, a level last seen during the height of Covid-lockdowns.

South Africa is not the only country whose currency has lost ground against the greenback in recent months.

Currencies around the world are buckling under pressure from the Fed, despite most central banks doing their best to keep up with the pace of rate hikes.

The US dollar index, which measures the dollar against a basket of other major currencies, has reached multi-decade highs last seen during the dot-com crash.

The Euro, Yen, Australian, New Zealand, and Canadian dollar have all hit record lows against the US.

The British Pound is outright crashing, having declined 8.2% against the USD in the past two weeks and 21.7% from its peaks in early January.

The most cited narrative is that central banks need to keep up with the Fed to protect interest rate differentials and guard against the weakening of their currencies.

The British Pound and the Japanese Yen have been punished in the past week for not following this trend and not matching the Fed’s rate hikes.

However, the movements in the rand did not quite follow that logic. After the Fed hiked rates on Wednesday, the rand strengthened despite being behind on interest rates.

It only started to weaken on Thursday when the South African Reserve Bank (SARB) matched the Fed with a 0.75% repo rate increase of their own.

It may be that the market was anticipating a 1.00% rate hike from the SARB, or it can be forward-looking.

RMB client strategist John Cairns said the SARB could not match the Fed point for point in rate hikes.

Firstly, the SARB does not meet often enough. They only have two meetings scheduled until the end of March, compared to the Fed’s four meetings over the same period.

The SARB will ultimately fall behind and see a decrease in the interest rate differential.

Interest rate forecast	United States	South Africa	Differential
23 September 2022	3.25% (+0.75%)	6.25% (+0.75%)	3.00%
2 November 2022	4.00% (+0.75%)	6.25%	2.25%
24 November 2022	4.00%	6.75% (+0.50%)	2.75%
14 December 2022	4.50% (+0.50%)	6.75%	2.25%
1 February 2023	4.75% (+0.25%)	6.75%	2.00%
22 March 2023	4.75% (Pause)	6.75%	2.00%
24 March 2023	4.75%	7.25% (+0.50%)	2.50%

Secondly, the South African economy is fragile, especially compared to developed markets, and will likely go into a deep recession if it continues this trajectory.

While the United States is already in a technical recession – with two quarters of negative GDP – its economy is still assisted by a resilient labour market and high consumer spending.

The graph below shows the USD/ZAR exchange rate compared to the interest rate differential – how much higher South African interest rates are than that of the US.

It shows that the interest rate differential significantly impacted the exchange rate from the beginning of 2022.

The SARB started hiking rates early in the cycle, which created a 0.75% buffer in the interest rate differential. It seems to have contributed to strengthening the rand earlier in the year.

Commodity Prices

South Africa’s economy partly relies on commodity exports, and commodity prices greatly impact the exchange rate.

The rand’s weakening at the end of April coincided with investors worrying about a global economic slowdown and the subsequent decline in commodity prices.

JP Morgan’s Anezka Christovova and Sean Kelly said weak Chinese economic growth is a significant risk to South Africa.

China is the biggest consumer of commodities and can have a big impact on the commodity prices that have helped South Africa to weather the global economic storm.

Christovova and Kelly said the rand is their preferred emerging market currency to short and project that it will gradually weaken to R19/$ by September 2023.

Final thoughts

The South African Reserve Bank is in a difficult position, having to walk a tightrope between protecting the rand and protecting the economy.

Global inflation is driven by constrained supply chains caused by Covid-lockdowns and geo-political tensions.

Another contributing factor is governments working against their own central banks with poor fiscal policies and frivolous spending programs.

Central banks have no control over these factors, and the Fed’s response is to increase interest rates to shrink demand and force the US economy into a recession.

As the world’s biggest economy, the US influences all other countries which are also suffering.

Because South Africa is an open economy, dependent on commodity prices, its economy and currency are at the mercy of global factors. The SARB can do little about it.

On the one hand, the SARB could slow or stop interest rate increases considering that inflation might already be trending down in South Africa.

It will allow consumers some relief and protect against unemployment figures that are already extremely high.

This strategy will weaken the rand, which South Africa might have to endure for a year.

The weakened currency could have some positive effects in offsetting declining commodity prices and providing support to tax revenues.

On the other hand, a weaker rand will increase the price of fuel and imported goods and could lead to inflation ticking up again.