South Africa’s rand on a roll

The rand has rallied strongly against the dollar over the past two months, going from R19.23/$ in mid-January to trading around R18/$ towards the end of March. 

This is mainly due to the Reserve Bank maintaining a substantial interest rate differential between South Africa and the United States to ensure that local assets remain attractive to investors. 

Investec chief economist Annabel Bishop explained this phenomenon in a recent research note, outlining how the rand has held its own against major currencies. 

The rand’s relative strength versus the dollar is in stark contrast to expectations at the beginning of the year, which anticipated the rand consistently weakening versus the greenback amid increased geopolitical tension. 

Heightened uncertainty typically benefits the dollar as investors flock to US-based assets as they are seen as a safe haven. 

Economists also expected US President Donald Trump’s trade policy to boost the dollar in the short term and weaken emerging market currencies. 

However, while the rand has seen some weakness versus the dollar at the beginning of the year, it has bounced back strongly in recent months. 

The local currency strengthened noticeably against the US dollar to R18.00 last week and is trading around R18.14/$. 

Bishop said the rand has seen particular volatility against the US dollar, trading at R19.23/$ in mid-January. 

At that stage, market expectations for US interest rate cuts had mainly been factored out for this year. More recently, markets factored them back in, with two cuts seen as definite in the remainder of this year. 

US interest rate cuts positively affect emerging market currencies, boosting the rand as local financial assets become relatively more attractive to investors. 

As a result, the rand also gained on the repo rate being left unchanged in South Africa last week, with the Reserve Bank‘s Monetary Policy Committee (MPC) not coming across as dovish, further bolstering the rand.

The US dollar index remains at a relatively moderate value, removed from recent highs in 2022 and January’s elevation. The US dollar has fallen since then, seeing only very moderate volatility in its downward trend.

Bishop said the rand has also gained some stability, as the MPC in South Africa is unlikely to cut interest rates in the first half of this year after January’s move. 

With the repo rate currently at 7.50%, the SARB’s “forecast sees rates stabilising at a neutral level of about 7.25%”, i.e. only one more cut in the cycle.

The MPC’s cut is forecast for 2025, with the repo rate remaining at this rate until the end of 2027, close to the previous meeting’s end-2027 forecast. Flat to higher interest rates in SA tend to support the rand.

Significant risks remain 

This outlook has significant risks, with the rand’s continued strength dependent on the Government of National Unity (GNU) holding and improved economic performance from South Africa. 

Since the formation of the GNU, the risk premium attached to South African assets has come down significantly. 

This has attracted foreign investors back to the country’s bond market, boosting the rand. Foreigners are yet to return to the country’s equity markets. 

Africa’s largest bank by assets, Standard Bank, expects the rand to continue strengthening against the dollar through 2025 but cautioned that significant risks remain.

It warned that the global environment remains extremely fragile amid ongoing geopolitical tensions and rising uncertainty about US policy changes. 

Currently, the bank’s main concerns are the uncertainty regarding US trade policy and the magnitude of China’s economic stimulus. 

These have the most potential to impact the rand’s value as the US has an outsized impact on financial markets, and China is South Africa’s largest trade partner.

The bank said that faster economic growth and improved financial management from the government would go a long way to minimise the potential impact of external forces. 

Standard Bank expects South Africa’s economic growth to accelerate off a particularly weak base due to the easing of infrastructure constraints, higher confidence levels, and reduced interest rates. 

Policy continuity, particularly fiscal consolidation and further structural reforms, is key to improving economic growth and potential rand strength. 

Under Standard Bank’s bear case, tensions within the GNU can jeopardize this outlook and reverse South Africa’s declining risk premium. 

If the GNU breaks up and a ‘confidence and supply’ agreement replaces it, confidence in South Africa will rapidly decline, and local financial assets will plunge. 

This would significantly weaken the rand against the dollar and lead to inflation spiking in South Africa, forcing the Reserve Bank to pause interest rate cuts and potentially hike rates.