After showing initial strength earlier this year, the rand has lost all its gains and then some, and is currently weighing in at its weakest level in over two years.
Monetary policy tightening: it’s all relative
South Africa’s inflation rate rose to 6.5% in May 2022, climbing above the upper limit of the target band and reaching its highest level since January 2017, while US inflation at 8.6% for the same month is the highest in over two decades, although it is showing signs of topping out.
The South African economy is expected to keep growing at a subdued pace below 2% until at least 2024, while inflation is also expected to retrace back to the midpoint of the SARB’s 3%-6% target band.
Table 1: Historic and forecast SA economic metrics.
The South African Reserve Bank (SARB) hiked rates by 50 basis points at its last monetary policy committee (MPC) meeting on 19 May, although you could argue this was a little too aggressive. Despite that, the market is pricing in a further 200 basis points in interest rate hikes in South Africa over the next year.
On the other side of the Atlantic, expectations are running high for further interest rate hikes. Most economists surveyed expect another 50 basis point hike at the US Federal Reserve’s (Fed’s) next meeting on 15 June, lifting their rate from 1% to 1.5%. It was more or less confirmed in the minutes from the Fed’s last meeting that it will hike rates by 50bp at each of its next two meetings and the market is pricing in around 220 bp in hikes in the coming twelve months.
With local inflation less aggressive than US inflation, the SARB has less need to keep up with the Fed, and should rather aim to stimulate local economic growth. While the SARB may believe it needs to keep up with the Fed to maintain our carry trade and avoid too much liquidity being drained from the country, the local economy has been underperforming for some time, and our GDP per capita was in decline even before Covid-19. For these reasons, the SARB might not be as hawkish as the US Fed in tightening policy over the next few years.
Weakest level in 24 months …
The rand strengthened against the dollar during the first quarter of 2022, starting the year north of R15.57/$ and reaching 14.40 at the end of March, before reversing and trading all the way back to and retesting the Nov 2021 highs at around 16.18 in April and May. After a brief rally, the local unit has since slumped to levels over 17.00, last seen in July 2020, in the wake of the load shedding crisis, rising electricity costs and soaring fuel prices.
… yet most of the collapse is due to dollar strength
The US dollar is at its strongest level in 20 years. The dollar index, which measures the value of the US dollar against a basket of six other major currencies, has strengthened some 12.7% since 1 January 2022 and 17.1% over the past 12 months, on the back of a hawkish Fed and the start of the US interest rate hiking cycle.
While other central banks are also on a tightening path – the SARB included – the Fed is doing so more aggressively than in the rest of the globe, hence the extreme strength of the US dollar. Combine this with a risk-off mindset provoked by recession fears in the US and Europe, the ongoing hostility in Ukraine and China growth concerns, which has seen a flight of assets to the safety of the greenback.
To some extent, rand weakness has been prompted by South Africa’s electricity crisis and load shedding, leading to fears of a recession for this economy too. At the same time the political jostling ahead of the ANC elective conference in December is creating a distraction for politicians and some fallout for the local currency. But the limited move of the rand on the crosses indicates that the vast majority of the currency’s move can be attributed to dollar strength rather than innate rand weakness.
Expect rand to remain under pressure in the short term
Although the rand has given up double the gains made in the first quarter, those levels around 14.50 were never sustainable. And while the rand is currently trading around 17.09, the magnitude and speed of the move from mid-April to now has been “too much too fast” and thus we believe that we could easily see some reprieve for importers from current levels.
We do, however, expect the rand to remain under pressure for at least the next quarter. We believe the Fed and SARB are both overly hawkish and once they move to a more gradual tightening path, both the dollar and the rand should weaken.
I think we will remain under pressure during the current quarter because of external factors and we may see the rand strengthening into the end of 2022 (as global factors become more favourable) and if they don’t see massive traction being gained from the RET faction in the build-up to the ANC elective conference in December.
The relative value is thus likely to remain more or less flat, although within a range of 16.40 – 17.50 in the near term and 15.80 – 17.50 over the next six months. The end of the Eskom strike, a return to normal power supply and any other positive news in respect of the rand could help the local unit to strengthen considerably.
Importers should look for dips below 16.50 to cover exposure, and keep buying down to 15.80 while exporters should wait for spikes back to 16.750 to step in and keep selling rand up to 17.50.