Can the Rand Sustain its Recent Relative Strength?

The current Rand/Dollar exchange rate level could be sustained if risk-on sentiment persist

The Rand became massively oversold during May 2023, and substantially underperformed most other emerging market currencies. In particular, at the end of May the Rand was down by -14.3% year to date, which compares with a decline of only -0.6% for the index of emerging market currencies.

However, after being the worst performing emerging market currency in May, the Rand is now the best performing emerging market currency, gaining 8.5% against the Dollar in the first half of June. In contrast, emerging market currencies, in aggregate, are up only 1.5%.

A range of factors may have contributed to the latest pullback in the value of the Rand:

The extent of undervaluation or sell off in May 2023 represented an attractive entry point for foreign investors as well as an opportunity for exporters to repatriate some Dollar earnings

An improvement in Eskom’s energy availability factor during June and therefore a very welcome scaling back of loadshedding

The SA/Russia arms scandal in May undoubtedly contributed to the extreme weakness in the Rand during May. However, there has not been any action taken by the US in response (although SA’s access to the AGOA agreement could still be cancelled), which may have helped the Rand’s performance in the first half of June 2023.

The US dollar has weakened against the Euro in recent days, partly due to the pause in interest rate hikes announced recently by the US Federal Reserve and a further 25bps hike in Euro-area interest rates – which obviously helps the Rand’s performance.

All of this raises the question as to whether the Rand can sustain its recent relative strength.

The current Rand/Dollar exchange rate level could be sustained if risk-on sentiment persists. While the Fed signaled that they would continue to hike rates at the next two FOMC meetings, the market is pricing in a 72% chance that the Fed will hike by 25bps on 26 July, but only a 12% chance of an additional rate hike on 20 September. This, together with a more hawkish ECB, will most likely result in further (modest) Dollar weakness. If these factors play out as the market anticipates, it will tend to support the Rand/Dollar exchange rate.

However, given that there is no compelling improvement in SA economic fundamentals, there remains a risk that the Rand could resumes its weaker bias, especially if the US needs to hike interest rates by more than the market expects or if the US decides to remove SA’s access to the AGOA preferential trade deal – although this is not our base case. Instead, the Rand is expected to trade in a relatively broad range of R18.10 to R18.60 over the coming months. The Analytics Currency Decoder, by DR. Lance Vogel, currently estimates fair value at R17.24/USD with current market at R18.35/USD.

Source: Alison Barker, Economist & Head of Analytics Consulting FX Solutions.

EMERGING MARKET EXCHANGE RATES VS RAND/US DOLLAR

% change June