Good news for the rand
The rand’s outlook is more optimistic as recent positive developments have reduced South Africa’s political risk and established a better base for growth.
Investec chief economist Annabel Bishop said the rand is potentially facing a more optimistic outlook, as Q2.24 has proved to be a quarter of positive developments.
These developments eroded the country’s political risk and established a platform for stronger growth and better investor sentiment.
“The downside risks have fallen substantially as the new government was successfully formed and translated into executive positions, with expected improved governance. This has lowered the risk premium for South Africa,” she said.
The likelihood has fallen for the downside of weakening investment growth and economic activity, fiscal deterioration, rising bond yields and inflation, rand depreciation, persistent load-shedding, and other structural constraints.
The rand has strengthened from R19.27/USD before the election on markedly elevated political risk with market fears of an ANC/EFF national coalition post-election. When this was avoided, the rand strengthened to R17.89/USD in relief.
In July, as South Africa’s market interest rate expectations changed due to the South Africa Reserve Bank’s (SARB) cut in its inflation forecast, the rand weakened back to R18.53/USD.
The rand losing ground against the greenback was because interest rate cuts in South Africa typically weaken the domestic currency.
The US and South Africa are expected to begin their interest rate-cutting cycles in September – the US on 18 September and South Africa the day after. This will maintain the narrow differential between the countries’ interest rates.
“The expected near-simultaneous start to the US and South African interest rate cut cycles has removed part of the impetus for rand strength, although neither is certain,” Bishop said.
“The rand likely would see marked strength on a delay for rate cuts in South Africa.”
The rand is currently trading at around R18.36/USD, running stronger as positive market sentiment towards South Africa persists on the increased likelihood of a better outlook, and this is reflected in the JSE and local bond markets.
Bishop said the rand has been volatile this year and has been negatively impacted by international and domestic events. The domestic currency is also affected by commodity prices.
However, she said the national election outcome is seen as a big shift for South Africa.
The rand would be much stronger now if the Reserve Bank had not shown a dovish tilt to its tone at the last MPC meeting.
The domestic currency would have likely run below R18.00/USD ahead of the US September rate cut without one expected in South Africa.
However, another positive sign is that foreign net purchases of South Africa’s portfolio assets since June have occurred, with R16.8 billion purchased on a net basis over June and July.
This rose to R23.5 billion after the formation of the GNU, parliament and the re-election of President Ramaphosa.
July has seen purchases net of sales of R19.7 billion worth of local bonds, which has underpinned the rand’s strength, although appetite waned after South Africa’s MPC meeting’s marked shift on the inflation outlook.
“While the domestic currency has been undermined recently by SARB dovishness, without positive market sentiment towards South Africa, the rand would likely be markedly weaker, and foreigners have been purchasing local equities too,” Bishop said.
“The reweighting of the probabilities, which now sees a 64% likelihood of the rand attaining the forecast in the expected case, versus only a 48% chance in Q2.24, also captures the improved financial market sentiment towards South Africa.”
While the rand has strengthened from its weak period before the country’s national elections, she said it is still weaker than a year ago and substantially weaker than in 2022, with the domestic currency still substantially removed from its fair value.
“Looking forward, the domestic currency is likely to be held back from rapid strength by the approach of the interest rate cutting cycle in September, aligning with the start of the US cut cycle, and so not providing a widening in the interest rate differential,” she said.
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