Rand may get unexpected boost soon

South Africa’s rand may get an unexpected boost this year as its emerging market peers cut rates before its Reserve Bank does, making its fixed-income assets, particularly government debt, more attractive to investors. 

This is feedback from Old Mutual Wealth investment strategist Izak Odendaal, who outlined why some emerging markets may cut interest rates before the US Federal Reserve does.

Odendaal said other central banks largely operate in the Fed’s shadow, with some larger entities, such as the European Central Bank (ECB), having leeway to start cutting rates sooner since inflation has fallen much quicker in Europe. 

However, as big and important an institution as the ECB is, it is still constrained by the Fed’s decisions, even if its officials would argue otherwise.

If its interest rates move too low relative to the Fed’s, the euro could fall and reignite inflationary pressures.

“When it comes to South Africa, there is no question that the Fed looms large in the Reserve Bank’s thinking,” Odendaal said. 

The US inflation numbers interrupted a promising rally in the rand recently. The weakening of the local currency was not due to election polls showing the ANC losing ground, he explained. 

“As the timing and depth of US interest rate cuts get pushed back, the same is probably also true for local rates.” This will have a weakening effect on the rand.

However, Odendaal said there is some hope for the local currency in the near future as its emerging market peers appear set to cut rates even before the Fed. 

He said there is a notable exception to the usual Fed story among emerging markets this time around. 

The big emerging market crises of the past few decades – especially the 1980s and 1990s – were caused by the Fed’s hiking and cutting cycles. 

These cycles introduce volatility, increase debt repayments, and negatively impact emerging market currencies – a recipe for trouble. 

There have been isolated cases of problems, with debt defaults by Sri Lanka, Ghana, Zambia and Argentina, a serial defaulter, but no widespread emerging markets contagion this time round. 

Many emerging economies have adopted floating exchange rates, built up foreign exchange reserves and reduced foreign borrowing.

This makes them more resilient to the Fed’s movements and allows them to cut rates if their local inflation drops sufficiently – without waiting for the Fed to cut first. 

Some emerging markets hiked rates aggressively and early, even before the Fed got going in 2022, giving them a headstart in the fight against inflation.  

These countries, including Brazil, Chile and Hungary, are now in a position to cut rates as domestic inflation has declined, even though the Fed has yet to move lower. 

“As they cut, South Africa’s short-term interest rates no longer seem relatively low in the peer group, and that should take some pressure off the rand,” Odendaal said. 

As its emerging market peers cut their rates, the interest rate differential will increase between them and South Africa’s.

In turn, the yield on their government debt and other fixed-income assets will move lower while South Africa’s remains high – making them relatively more attractive to investors hungry for yield. 

This should result in money flowing into the country, strengthening the rand.