End of an era has rand set to soar

The South African rand is poised to benefit in the coming years from a US dollar that is on the back foot, as long-term trends and short-term policy shifts prompt investors to diversify away from the world’s largest economy. 

This will be coupled with higher inflation for longer in the United States as the country looks to reshore much of its manufacturing, weakening the US dollar. 

As a result, the US currency will depreciate against most currencies around the world, including the rand, if South Africa continues on its path of reform and fiscal consolidation. 

This is feedback from Old Mutual Investment Group (OMIG) portfolio managers, John Orford and Graham Tucker, who produced the asset managers’ annual Long-Term Perspectives report. 

The report aims to analyse long-term trends in financial markets and the global economy, not only to inform current investment decisions, but also to show the value of a long-term perspective when investing. 

One of the longer-term trends identified by Orford and Tucker was the declining use of the US dollar as a reserve currency by central banks and the diversification of investors away from American assets. 

This comes after nearly twenty years of US outperformance, with American technology stocks driving most of the returns for investors. 

Orford explained that due to this, US-listed equities are priced for perfection, with assets outside of the world’s largest economy looking more attractive on a valuation basis. 

With the radical shift in US trade policy under President Trump, this outlook will be affected, and inflation will be higher for longer as companies reshore their operations or pass tariffs onto the consumers. 

Higher inflation will likely translate into higher interest rates in the United States, affecting the returns on offer to investors. 

This will result in a shift in investor behaviour to other countries, where rates are less restrictive and there is more policy certainty. 

When coupled with the United States’ huge debt load and continued deficit spending, yields on U.S. Treasuries and other fixed-income assets are expected to rise. This will increase the cost of borrowing for the US government, crowding out spending in different areas. 

The huge debt load and substantial deficit are also weighing on the US’s creditworthiness, resulting in some investors selling out of US Treasury bonds for other assets. 

All of this translates into less demand for the dollar, resulting in a weaker greenback and a relatively stronger rand in comparison. 

The graphs below show the expected impact of tariffs on imports into the United States on the country’s economic growth and inflation.

The US dollar is overvalued

All of these headwinds for the dollar come at a time when the greenback is heavily overvalued following a period of US exceptionalism. 

Purely based on fundamentals and the cyclical nature of currencies, Orford and Tucker expect the dollar to depreciate against most currencies in the coming years to return to its fair value.

Coupled with the higher inflation in the United States compared to its peers and historic levels, the dollar is likely to lose significant value. 

This all pushes investors out of US assets and the dollar towards alternatives, such as the euro and European assets, as well as the yen and Swiss franc. 

The primary beneficiary of the search for alternatives to US fixed-income investments and the dollar has been gold, with central banks and investors alike pumping money into the precious metal. 

Tucker explained that emerging market central banks, such as China and India, have been particularly attracted to gold to diversify their reserves away from the dollar. 

Even for ordinary investment funds, gold is becoming a more attractive asset as it is uncorrelated with equities and bonds. 

Orford explained that this does not mean the dollar is near its end or will collapse, but rather that it might be the beginning of the end for the currency’s superior status. 

As the world becomes increasingly multipolar and investors diversify, other assets and currencies will begin to take some share from the greenback. 

Orford also poured cold water on the idea that this might significantly boost South African assets, as local economic fundamentals have to change before investors return to local markets. 

South Africa’s economy has to grow much faster, the government’s creditworthiness has to improve, and policy uncertainty must be reduced for significant capital to flow back into local assets. 

The graphs below illustrate the current overvaluation of the dollar and how central banks are diversifying their reserves away from the US dollar.