Two-decade surprise for the rand

The rand is experiencing a period of extremely low volatility, with its trading range against the dollar being at its narrowest in two decades. 

This could indicate that local asset managers are allocating more capital towards local investments and that some foreign investors are betting on the currency recovering. 

It could also signify a shift in the rand’s risk profile, with the risk premium attached to South African assets declining since the formation of the Government of National Unity (GNU) in June 2024. 

RMB asset class solutions specialist Hakeem Philander recently outlined some of the driving forces behind the rand’s low volatility in a research note. 

The South African rand is experiencing a period of remarkably low volatility, with its trading range against the US dollar shrinking to levels not seen in over two decades. 

“This unusual stability, despite the rand trading near its weakest historical levels, suggests a significant change in its risk profile,” Philander said. 

Last year, the USD/ZAR exchange rate saw its smallest trading range since 1999. This means the rand’s value fluctuated less than it has in years, even during times when it was at a low point. 

“To put it simply, the rand’s ups and downs have become much smaller and less frequent,” Philander explained. 

This drop in volatility isn’t happening in isolation. It mirrors a broader trend in the global currency market. Major world currencies, like those of the G7 nations and other emerging markets, have also seen their volatility decrease. 

“In fact, global emerging market currency volatility hit an all-time low last year. This global trend is a major factor influencing the rand’s behaviour,” he said. 

Volatility most likely reduced throughout last year as investors adopted a wait-and-see strategy regarding the many elections that happened around the world in 2024.

Most investors during this period would have taken their chips off the table and waited for the dust to settle before trying to pick winners and losers.

Volatility has also declined as part of the US’ continued outperformance, which has sucked most global liquidity into dollar-based assets.

While global factors play a big role, there are unique aspects to the rand’s situation and relative weakness compared to the dollar. 

Most notably, the cost of insuring against extreme rand weakness has reduced significantly. This suggests that investors’ perceptions of the rand’s risk have fundamentally changed.

Philander also explained that local asset managers have been selling their foreign investments when the rand weakens to capitalise on profits and have allocated some of the proceeds into South African assets, boosting the currency.  

“This trend was very noticeable in 2020, and there were signs of it in 2016 and 2024. This means that, increasingly, local investors are more likely to sell off their assets held in other countries when the rand gets weaker.”

One reason is that investors believe the rand will eventually recover, so they see the rand’s weakness as a good time to sell foreign assets. 

On the flip side, when the rand strengthens, they may see it as a good time to take money offshore and invest globally, weakening the currency. 

Another is that regulations limit the amount of foreign investment these firms can hold, and a weaker rand pushes them over those limits, forcing them to sell. 

“Or, it could simply be that when the rand weakens, it’s a sign of general financial stress, and these firms are selling off assets to get cash or adjust their investments.” 

Philander said it is crucial to understand that lower volatility does not mean the rand is risk-free or in a stronger position. 

“The rand remains more volatile than many other currencies. What it does mean is that the types of risks and how they’re managed need to be looked at differently,” he explained.

Looking ahead, there’s a question mark over how long this period of low volatility will last. Uncertainties in the US political landscape may increase global currency volatility. 

However, Philander explained that, historically, market volatility only tends to increase when the US economy enters a recession.

If global volatility rises, it’s likely that the rand’s volatility will follow suit.

“While this provides a period of relative stability, it’s crucial to remember that risks remain. Businesses and investors must be aware of these changing dynamics and adapt their strategies accordingly,” he warned.