The following article was commissioned by Dynasty for our clients and compiled by our research partner, Analytics Consulting, as represented on our Investment Committee.
Since South Africa went to the polls on 29 May of this year, the USD/ZAR exchange rate has moved from a level of R18.40/$ on that day to a level of R17.11/$ on 27 September. This strength has been interpreted as a significant vote of confidence in the new Government of National Unity (GNU), representing a currency development that is reminiscent of the period of “Ramaphoria” that swept across the country following Cyril Ramaphosa’s victory over Jacob Zuma at the ANC’s Elective Conference in December 2017.
As depicted in the chart below, on 28 June 2017, the rand was at a closing level of R12.94/$. On 13 November 2017, it closed at a level of R14.47/$, having weakened by just under 12% over that period. What followed was a bout of US dollar weakness and a growing optimism that Cyril Ramaphosa would be victorious, and these combined tailwinds drove the rand down to a level of R11.55/$ by 26 February 2018, following Ramaphosa’s election as president of South Africa on 15 February 2018. Over a period of about three months, the exchange rate had strengthened by 20%, and “Ramaphoria” engulfed the nation as the prospect for much needed structural reforms and a repurpose of government focus gained momentum. However, with the reality dawning that President Ramaphosa did not have the political space to drive the country forward in a positive way, the exchange rate started to weaken, and by 6 September 2018, our currency had weakened by 33% to a level of R15.31/$.
The Dynasty Investment Committee has access to a unique currency analysis tool called the Analytics Currency Decoder. This purely quantitative Decoder does not seek to model the behaviour of a currency but rather uses a basic form of Artificial Intelligence to “decode” the exchange rate to extract long-term stability characteristics that can be used to estimate an equilibrium or “fair value” for the exchange rate at any point in time.
When the rand was at a level of R12.94/$ at the end of June 2017, the Decoder estimate for fair value was R13.04/$ meaning that the USD/ZAR exchange rate was correctly priced. In November 2017 when the rand was at R14.47/$, the Decoder estimated fair value to be at R13.03/$. While the currency had weakened by around 12%, fair value had hardly moved. The long-term consistent mean reversion nature of currency levels around the Decoder fair value estimate meant that a bout of strength could be expected. All that was needed was a catalyst. Ramaphosa’s anticipated victory in the Elective Conference was that catalyst and, on 18 December the rand closed below that R13.03/$ level at a spot level of R12.75/$. On that day our fair value estimate was at R12.97/$ suggesting that the rand was again close to fair value and correctly priced.
On 26 February 2018, with the rand rate at R11.55/$, the Decoder estimated fair value to be at R12.50/$, suggesting that the local currency’s strength was overdone and that some weakness could be anticipated. Once again, all that was needed was a catalyst. This time the catalyst was disappointment on the local political front. On 30 April 2018, the rand closed at R12.46/$, very close to that estimated fair value level. In the meantime, a stronger US dollar had pushed the fair value estimate up to R12.82/$, suggesting that the weakness would continue. This was indeed so as the rand continued weakening to the 6 September 2018 level of R15.31/$ with fair value at R13.42/$. The rand had emphatically declared “Ramaphoria” to be officially dead.
The influence of the US dollar, through the fair value estimate, was very muted over that period of time. In stark contrast, the USD/ZAR exchange rate gyrated wildly from a level of R12.94/$ to R14.47/$ to R11.55/$ and back to R15.31/$ based on country-specific swings in sentiment and, to a much lesser extent, aggregate Emerging Market effects.
Moving on to 2024 we can observe a similar pattern of rand strength following the formation of the Government of National Unity (GNU) on 14 June:
As depicted in the above chart, on 23 February this year the rand closed at a level of R19.31/$, with around three months to go before our national election. Fair value was estimated to be much lower at R17.82/$. That weakness relative to fair value was a result of the residual effects of the intense load-shedding schedule and the #Lady R arms scandal in the first half of 2023 that were still present in the rand nearly a year later. Once again, the Decoder suggested that rand strength could be expected. The catalyst in this case was the expectation that the ANC would lose significant support and that a coalition government would have to be formed. This was viewed as a best-case outcome for the country. By election day, the rand had strengthened to R18.40/$, a gain of nearly 5%, and fair value was estimated to be at R18.18/$, again suggesting that slightly more strength could be anticipated.
On 18 June, the exchange rate closed below the election day fair value estimate, at a spot level of R18.04/$. The Decoder then pegged fair value at R18.23/$, suggesting that the currency was slightly stronger relative to fair value. Since then, further strength materialized and on 27 September the exchange rate closed at a level of R17.11/$, with fair value at R17.46/$. In this case, while the exchange rate had strengthened by 7%, fair value had been driven down by nearly 4% by a weaker US dollar. The strength in the last four months has been a nearly equal combination of local positive developments predominantly in June, and the weaker US dollar over the subsequent three months. This is a significant contrast to what happened after the ANC Elective Conference in 2017 where the strength was almost entirely driven by local positive sentiment.
From the level of R17.11/$ on 27 September the rand has subsequently moved weaker to the current level of R17.65/$, passing through the fair value estimate of R17.46/$ (decoded on 27 September). Some recent strength in the US dollar has moved the current estimate of fair value up further to R17.82/$.
While the current estimate for fair value suggests that the strength that has been seen since the election day is overdone, further strength cannot be ruled out. However, the Analytics Currency Decoder indicates that further strength will most likely come from improving aggregate Emerging Market effects as opposed to further local positive sentiment. However, it is true that the current level of positive local sentiment in the currency is very close to that seen during the “Ramaphoria” period. This potentially leaves a lot of room for disappointment if the GNU fails to live up to expectations.
Our current target for the exchange rate is the fair value estimate of R17.82/$. In addition, per our other article in this quarterly relating to the level of the US dollar, the weakness in the dollar may also be overdone as we believe that the expectation of rate cuts by the US Federal Reserve, which are already priced into the US dollar, maybe too optimistic. Should our view materialise, the stronger US dollar will put some upside pressure on fair value which will translate into some further weakness for the rand/dollar exchange rate from current levels. Any future disappointment in the GNU will only add to a technical weakening trend in the exchange rate.
