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In depth: The state of the South African rand

The rand has had its best month against the dollar since the global financial crisis and has pierced a number of key resistance levels against the euro and pound. But it is too soon to believe that the worst may be over.

Last week contained several positive surprises that bolstered the rand.

The first was US Federal Reserve chair Janet Yellen’s dovish comments last Wednesday that only “gradual increases” in the federal funds rate are likely in coming years. This pared US rate-hike expectations right back, causing dollar weakness and a resurgence in risk appetite for emerging-market assets.

This allowed the rand to fall through the key resistance levels of R15/US$, R17/¤ and R22/£ on the same day.

The dollar lost about 3.6% during March on a trade-weighted basis and is now 6% off its December high, according to Rand Merchant Bank (RMB). Its technical team thinks the dollar/rand bull market that has prevailed since 2011 may be over.

The second major boost to the rand was the constitutional court’s unanimous finding last Thursday that President Jacob Zuma and parliament had flouted the constitution in their handling of the public protector’s Nkandla report.

The ruling was seen as strongly positive for the country because it was unflinching in holding the executive and legislature to account. In so doing, it also reinforced the institutional independence and integrity of the judiciary and the public protector — and if there is one thing that international investors say sets SA apart from other emerging markets it is the strength of the country’s institutions.

In response to the verdict, the rand rallied to an intra-day best of R14.66/$, breaking through the R14.88/$ close it reached on December 9 last year when Zuma sacked former finance minister Nhlanhla Nene, a debacle commonly known as “Nenegate”. The rand subsequently weakened all the way to R17/$ in January.

“It’s been quite staggering the extent to which the rand has recovered,” says Barclays Africa currency strategist Mike Keenan. “Unless the world tips towards a risk-off environment, I think the rand could consolidate these gains and maybe gain a bit further towards the R14/$ handle before continuing on a long-term depreciating trend.”

March was a great month for emerging markets as a whole, driven by Fed dovishness, the European Central Bank easing monetary policy on deflation fears, and China’s willingness to provide further stimulus to its economy. In addition, China’s purchasing managers’ index (PMI) jumped to a nine-month high in March.

Capital inflows into emerging markets totalled a whopping $37bn during the past month, according to the Institute of International Finance, while a Bloomberg index of 20 developing-nation currencies rose 5.5% in March — the best monthly run for emerging market currencies in 18 years.

The rand, which had become overstretched since Nenegate, was a prime candidate for a turnaround and has been one of the best performers.

In the final week of March, it rebounded to about R14.70/$ at the close from R15.46/$ at the start, a rise of about 5% in seven days.

Local news also supported the rand during the week. February’s trade balance came in smaller than expected thanks to a surge in exports; the Barclays manufacturing PMI posted above 50 index points for the first time in almost a year, suggesting some of the pessimism regarding the sector may be overdone; and producer price inflation rose by less than feared, to 8.1% year on year in February

As a result of all these factors, split roughly equally between foreign and domestic effects, the rand has broken through the steep upward trend line against the dollar that has held since 2014.

This is just one technical factor among several that suggests that the dollar/rand exchange rate may have printed its high for this cycle.

“There is some optimism coming back into the market,” confirms RMB currency strategist John Cairns. “We remain entirely convinced that the rand is heavily oversold and will recover in the medium to long term (one year and out), though there is still potential for weakness in the short term.”

Cairns had previously forecast the rand to end the year at R16. 50/$. RMB will likely revise that forecast lower in the coming week.

Mohammed Nalla, head of strategic research at Nedbank Corporate & Investment Bank, is less convinced. There are two main reasons why he still expects the rand to end the year at his initial forecast of R16.80/$.

First, he still expects the Fed to hike this year, probably in September by 25 basis points, because, though sub-par, the US economy is still growing.

And because the Fed is the only major central bank to be hiking rates, this would likely cause a new leg of US dollar strength, possibly a rise of as much as 8%-10% on a trade-weighted basis.

Secondly, he points out that while the constitutional court’s ruling was important for a return of investor confidence, it was not enough. SA is still not clustered with the higher-quality emerging markets such as India, Mexico and Malaysia.

“A lot of investors are underweight in SA, and some even prefer Brazil because they feel it has bottomed out — whereas SA has further to fall because many still see downgrades as inevitable,” Nalla says.

“SA is seen as an also-ran because we still need to undertake structural reform and need a compelling growth plan to win investors back.”

Keenan agrees that SA still doesn’t have a fundamentally good story to tell. The economy is weak, inflation is rising, the twin deficits on the national budget and current account remain, and the country faces a very real prospect of credit rating downgrades.

“I’m more constructive on the currency than I was earlier this year,” says Keenan. “But I’m not an all-out bull yet because SA still has these nagging fundamental concerns and still faces the very real prospect of losing its investment-grade credit rating.”

The rand could spike if the country’s credit rating is downgraded but, even if this doesn’t materialise, Nalla still thinks the rand will end the year weaker simply because of rising inflation.

Nedbank also has the most bearish 2016 real GDP growth forecast in the market for SA, at just 0.2%.

It places a high probability on SA sliding into a technical recession between the second and third quarters of the year. This is mostly because it expects consumer spending, which has been mildly supportive until now, to become an additional drag on growth as the cost of living rises.

Clearly, the rand is not out of the woods yet.

Source: Rand Daily Mail

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