South African Rand (ZAR) - December 2016

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Donald Trump’s election and the prospects for added fiscal stimulus in the US has brought about a significant increase in interest rate hike expectations and a strong rally in the US Dollar. We expect the Federal Reserve to hike interest rates in December followed by further increases on a quarterly basis thereafter. Meanwhile, almost every other G10 central bank remains overwhelmingly in easing mode.

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. However, Trump’s victory introduces an element of uncertainty. The prospects for each particular emerging market currency will be highly dependent on two factors:
● The country’s position as a commodity exporter or importer, as exporters will benefit from our expectations for worldwide reflation.
● The impact of potential restrictions on trade passed by the Trump administration on trade flows.

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 last year, 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 uncertainty that has plagued the country throughout much of the past year.

However, the Rand has rebounded strongly so far this year, rallying to a thirteen month high against the US Dollar in November (Figure 1). The currency has appreciated by close to 20% since early January, in line with our forecasts, making it one of the best performing emerging market currencies in the world in 2016. Despite falling sharply in the immediate aftermath of Donald Trump’s election victory, the currency has since recovered the majority of its post-election losses.

Figure 1: USD/ZAR (2011 - 2016)

Source: Thomson Reuters Datastream Date: 14/12/2016

This year’s recovery in the Rand has been helped along by a general improvement in economic news out of South Africa. The economy returned to growth in the second quarter of the year, having contracted by 0.1% on a year previous in the first quarter, growing by 0.6%. This was largely due to an impressive performance in the manufacturing and mining sectors which expanded by 8.1% and 11.8% respectively.

South Africa’s economy has been heavily affected by falling commodity prices, which accounts for around 60% of overall export production. The central bank now expects the economy to grow by just 1.2% in 2017. However, we see significant risk of an upward surprise given the rebound in commodity prices and lessening effect of the El Niño induced drought in Southern Africa.

Headline inflation in the country has increased in the past few months due to the weak currency, although at 6.6%, is only just above the South African Reserve Bank’s (SARB) inflation target range of 3-6% (Figure 2). The central bank warned at its November meeting that it may have to hike rates again in order to alleviate inflationary pressure.

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

Source: Thomson Reuters Datastream Date: 14/12/2016

Amid the general improvement in economic conditions, political uncertainty remains a risk to the currency. South Africa’s controversial and widely unpopular Prime Minister, Jacob Zuma, who has been plagued with allegations of corruption since 2009, survived a vote of no confidence in November. Support for Zuma’s ruling ANC Party has waned of late, with the Prime Minister dogged by a court ruling earlier in the year that he violated the constitution over the personal use of taxpayer funds.

Foreign exchange reserves have dipped slightly in real terms, although remain at a sufficient level at the equivalent of around seven months’ worth of import cover (Figure 3). 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. The Rand also remains at very cheap levels following its recent sharp depreciation, which should provide an attractive proposition to investors.

Figure 3: South Africa Foreign Exchange Reserves (2000 - 2016)

Source: Thomson Reuters Datastream Date: 14/12/2016

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 has been positive throughout most of the year so far, having 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.

Our long standing forecasts for a recovery in the Rand have been justified by the impressive performance of the currency so far in 2016, which has been as one of the best performing emerging market currencies in the world.

Despite the relatively fragile political backdrop, there remain a number of key supporting factors for the Rand this year and we continue to expect the currency to remain well supported against the US Dollar during 2017:

● In order to protect the Rand and alleviate inflationary pressure, the South African Reserve Bank (SARB) aggressively hiked its interest rate last year, raising rates by a further 25 basis points to 7% in March. The interest rate is therefore slightly above the level of inflation meaning that real interest rates are positive, which should provide good support for the Rand (Figure 4).
● Commodity price increases are panning out in a way that is favourable to South Africa. In fact, its terms of trade, which measures the prices of its exports compared to those of its imports, has improved markedly this year.
● The other risk factor we identify above, the impact of potential trade restrictions imposed by the Trump administration, should be quite small. They amount to less than 8% of total exports, and are mostly in the form of raw materials for which the US has no domestic substitute.
● Ample level of FX reserves and relative cheapness of the ZAR further support our view for a well-supported Rand.

Figure 4: South Africa Interest Rate vs. Inflation (2008 - 2016)

Source: Thomson Reuters Datastream Date: 14/12/2016

Given the recent strength of the Rand, we are revising or short term forecasts modestly lower, and expect a long term stabilisation at around 14 to the US Dollar. We think that the large scale monetary easing measures launched by the European Central Bank in the Eurozone should ensure a relatively sharp appreciation of the Rand against the Euro, even while it holds its own against the US Dollar.


























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