Morning Brief – Framing

Framing

The Rand’s appreciation over the past few months has been significant. Against a strong and still rising GBP, ZAR is one of only a small handful of currencies that has gained ground versus the Pound so far this year. One of the major risks that could have abated further Rand strength presented itself last week. On Wednesday and Thursday in South Africa, CPI inflation and the latest monetary policy decision from the South African Reserve Bank’s (SARB) Committee was released. The conclusion: the events did not manage to materialise into a barrier and resistance to the Rand paving the way for continued ZAR strength within its major crosses.

The reason the Rand is outperforming is down to the premium that the FX forward market is affording Rand crosses across the curve. Due to the implied interest rate in most ZAR crosses outstripping the yield on Jo’burg listed debt, the Rand is gaining favour. Despite this, if inflation had been shown to run hot in South Africa as the economy normalises following a series of rolling lockdowns, pressure could have mounted for the Rand to deteriorate. With the rate of interest in South Africa having deteriorated from 6.5% down to 3.5% during the course of the pandemic, a rising rate of inflation risks the rate of real return on capital held in South Africa falling into deeply negative territory. So too, the following day, if the SARB has signalled a continued push towards lower rates of interest, a similar negative real yield concern could have forced a correction in the upward appreciation of the Rand.

As it happened both the data release and the Committee trod a path through the downward risks to the Rand to set the stage for further Rand strength. When inflation was read on Wednesday, whilst generating a negative real yield, the data was not observed dramatically above consensus forecast, nor above the SARB’s own target range. With only a mildly negative real yield in an environment of deeply negative real and nominal rates worldwide, the Rand took the reading in its stride, relatively unchanged by the data event. Next came the turn of the SARB. Whilst the private central bank has demonstrated its commitment recently to keeping rates at record lows in order to encourage a stronger economic recovery, a hyper-dovish decision signalling further cuts and monetary support could still have led to a reversal in the currency. Contrary to this downside risk, the central bank revised growth upwards for 2021 and highlighted new upside risks to inflation, opening the door to tighter monetary policy. Whilst the Committee kept rates on hold in a unanimous decision, the rhetoric used appeared to begin to frame a forthcoming cycle of monetary tightening. This should prove positive for the Rand in the coming months.

As a result of the market’s expectation of rising reward for holding the South African Rand in nominal and (based on the inflation reading likely) real terms, the currency appreciated. Following a strong rally versus the Dollar year to date the Rand could enter new trading ranges if it breaks critical resistance levels below 14, in line with 2019’s closing value.

Discussion and Analysis by Charles Porter

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