By Neels Heyneke, Macro Strategist and Andre Botha, Senior Dealer
Last week an interesting phenomenon occurred: the rand lost significant ground against the US dollar and therefore other currencies as well – but without no apparent reason. While the rand losing ground is nothing new and has happened plenty of times in the past, it normally coincides with either a stronger US dollar or domestic issues. However, this time around there was no domestic reason for the rand to rally as hard as it did and the US dollar stayed relatively stable.
So what could be the possible reason for the rand weakness? We heard some rumours that load shedding and the impending election may have an effect on the rand. We feel that load shedding has been with us for quite some time and no fireworks were expected from the election, so it would suggest that none of these factors could have that drastic effect on the rand.
The reason for the rand weakness is a little more complicated than purely looking at the US dollar, and in fact, has more to do with interest rate curves and money market rates across the world. There has been a lot of volatility in these rates as it has become evident that inflation is not as transitory as was expected.
Some effects from the inflation and interest rate conundrum currently in the market is that Central Banks have started to renege on promises it issued, like the Royal Bank of Australia removing its forward guidance, or in other words, yield curve control. This has skyrocketed rates in the short term, as we have seen the South African FRA curve is now pricing in a total of 3% interest rate hikes in the next 2 years. A 3% total hike is a bit mispriced, in our opinion, given the current state of the economy, but clearly shows how disjointed the market is.
In all this disjointedness the market is struggling to find its feet and a number of investors were forced to close some of their positions, as the sudden move of the market caught a lot of people unaware and got margined called. Because there was a forced sell-off in the money market space, the contagion effect was that the “risk-off” notion spread through to emerging markets, specifically the rand especially that stands as a proxy currency for the rest of EM currencies.
That was last week, and while the uncertainty is still in the market, this new (short) week brings with it some new challenges. The biggest challenges are from the US side of the market, with the FOMC decision today and the US non-Farm payroll number out on Friday.
The major risk from the Fed is that the Fed turn hawkish and announce a taper as well as an indication of possible future rate hikes. However, we expect the Fed to stay decidedly dovish, and with financial conditions as they are at the moment, the Fed can’t risk further pressure on the global financial system and can’t tighten conditions quickly. We therefore see the US Dollar on the backfoot and the rand clawing back some of its losses of the past few weeks.
While we have the Fed meeting tonight, it is also important to see what the charts tell us about important levels that need to break or hold.
We have seen in the Dollar Index that the dollar was in a weakening phase last year (blue lines). This was mainly due to the aggressive policy by the Fed during Covid. This year, we have seen a bit of a rebound in the dollar index but nothing in the way of the blue trend of 2020. With a wedge forming, the DXY making higher lows, the break normally is to the steeper side, we expect the 94.68 level to hold firm, should the Fed stay dovish as we expect. If the tone changes from our expectation a break to the top side is likely.
From the chart above, the rand has now trading towards all the USD highs in the past 11months or so and is also making higher lows. This can be shown by testing R13.50 in June before weakening and recently only back to R14.50. It is interesting to note that both the Dollar Index and the rand has followed the same trends for the past couple of years. We feel that the move from R14.50 to R15.50 was too quick and that the rand should again trade below the R15.28 neckline of the wedge. If the Fed stay dovish we could see the rand test the bottom line of the wedge in the medium term which is around the R14.50 level. For now, we do feel that the USD/ZAR is still within our broader R14.25 to R15.35 range. The announcement by the FED tonight is key and we expect the ZAR to take a bit of a breather back towards the R15.00 in the short term.