South African Rand (ZAR) - September 2016

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The UK’s shock Brexit vote in June and a relatively weak US labour report in August has now ensured we’re unlikely to see multiple interest rate increases in the US in 2016. We now expect just one hike from the Federal Reserve in December followed by further increases on a quarterly basis thereafter. Meanwhile, almost every other G10 central bank remains overwhelmingly in easing mode.

In the UK, the Bank of England cut interest rates for the first time in nine years in August, with the European Central Bank looking likely to expand its quantitative easing measures later in 2016. Further, the Bank of Japan announced a modest expansion of its monetary stimulus program, while the Japanese Government will significantly expand stimulus spending.

We think that the backdrop of extraordinarily stimulative policy from the main central banks, with the notable exception of the Federal Reserve, and a clear shift towards more accommodative policies in the laggard economies (e.g. Japan) is generally positive for risk assets and emerging market currencies in particular.

The South African Rand (ZAR) has recovered well in line with our expectations so far in 2016. The currency plunged in value towards the end of 2015, falling sharply to an all-time low level against the US Dollar in mid-January amid concerns about the health of the South African economy and political turmoil that has plagued the country throughout much of the past year. However, the Rand has rebounded so far this year, rallying to its strongest position against the Dollar in 10 months in August (Figure 1).

Figure 1: USD/ZAR (2011 - 2016)

Source: Thomson Reuters Datastream Date: 26/09/2016

This recent recovery in the Rand has been helped along by a relatively weak US Dollar and generally better-than-expected economic news out of South Africa. Headline inflation in the country seems to have peaked and, at 5.9% in August, is now finally back within the South African Reserve Bank’s (SARB) inflation target range of 3-6% for the first time this year.

There are also some signs that economic activity is rebounding somewhat, spurred on by the positive effect stemming from a cheaper currency. The manufacturing PMI has increased since the beginning of the year, registering above the key level of 50 that denotes expansion in each of the five months to July, albeit falling again to 46.3 in August.

Economic growth also picked up again the second quarter of the year following a sharp slowdown in the past few years that culminated in the economy contracting by 0.1% in the first three months of the year for the first time since 2009. Overall GDP expanded by 0.6% in Q2 in annualised terms (Figure 2), due largely to an impressive performance in the manufacturing and mining sectors which expanded by 8.1% and 11.8% respectively.

Figure 2: South Africa Annual GDP Growth Rate (2006 - 2016)

Source: Thomson Reuters Datastream Date: 26/09/2016

However, the economy is still widely expected to grow by less than 1% in 2016. The SARB revised upwards its growth forecast to 0.4% from zero at its September meeting, with the threat of recession receding following the slowdown in inflation and lessening effect of the El Niño induced drought in Southern Africa. South Africa has been heavily affected by falling commodity prices, which account for around 60% of overall export production, and the economic slowdown in China, the country’s largest trade partner.

The political situation in South Africa has also become increasingly uncertain in the past few months. In April the country’s controversial and widely unpopular President Jacob Zuma barely avoided an impeachment vote in parliament. Zuma has been dogged by allegations of corruption since his election in 2009 and was widely criticised in December when he changed Finance Ministers twice in one week, sending the Rand plunging to a record low level.

Despite economic and political problems, there remain a number of key supportive factors for the Rand which have aided the currency’s recovery and should keep ZAR well supported throughout the remainder of this year. In order to protect the Rand and alleviate inflationary pressure, the South African Reserve Bank (SARB) has aggressively hiked its interest rate since last summer, raising rates by another 25 basis points to 7% in March. The interest rate is therefore above the level of inflation meaning that real interest rates are now comfortably positive, which should provide good support for the Rand (Figure 3).

Figure 3: South Africa Interest Rate vs. Inflation (2008 - 2016)

Source: Thomson Reuters Datastream Date: 26/09/2016

The recent sharp decline in oil prices and South Africa’s characteristic as a net importer of oil has benefitted the balance of trade which registered a record high surplus in May. The sharp Rand devaluation has also significantly increased the competitiveness of the South African economy and we expect exports to provide a pleasant upward surprise in 2016.

Foreign exchange reserves have dipped in real terms, although remain at a sufficient level at the equivalent of around eight months’ worth of import cover (Figure 4). This should provide plenty of ammunition for the central bank to intervene in the currency markets in order to prevent another excessive sell-off in the Rand, if required.

Figure 4: South Africa Foreign Exchange Reserves (2000 - 2016)

Source: Thomson Reuters Datastream Date: 26/09/2016

We thought at the time that the sell-off in the Rand at the beginning of the year was excessive and our long standing forecasts have been justified by the sharp reversal in sentiment towards the currency so far in 2016. We think that the supportive factors for the Rand, mainly the cheapness of the currency and sufficient FX reserves, should ensure a further recovery in ZAR against both the US Dollar and Sterling throughout the remainder of the year.

The large scale monetary easing measures launched by the European Central Bank in the Eurozone should, in our view, ensure an even greater appreciation of the Rand against the Euro.

 

 

USD/ZAR

EUR/ZAR

GBP/ZAR

E-2016

14.25

14.54

18.95

Q1-2017

14.20

14.06

18.74

Q2-2017

14.10

13.68

18.47

Q3-2017

14.05

13.49

18.27

E-2017

14.00

13.30

18.20

E-2018

13.75

13.06

17.88

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