Rand wilts on Fed’s surprise hawkish signals

The rand suffered with other higher-yielding currencies after the US Federal Reserve (Fed) surprised many markets by signalling an earlier-than-expected increase in its interest rates, which may starve countries such as SA of capital.

Still, higher commodity prices should limit the damage while the Reserve Bank is likely to refrain from hiking rates, because weak consumer demand will constrain inflation and keep it comfortably within its target range, enabling it to keep supporting the economy with a record low repo rate. Sustained weakness in the currency increases the risk that price increases will accelerate by making imports such as oil and commodities priced in international markets more expensive.

That is in contrast to major emerging market peer Brazil, whose prior failure to contain price increases has prompted it to raise rates three times already in 2021. The last one on Wednesday, a move of 75 basis points, took its main rate to more

than double the 2% historic low from earlier in 2021.

Among developed markets, Norway’s central bank indicated it would start hiking rates from September.

SA’s repo rate has been at 3.5% since July 2020, the lowest any official rate has been in about five decades.

The rand, which is a proxy of sentiment towards emerging markets because of its highly tradable status, shed 1.5% on Wednesday night, in what was thin after-hours trade during a public holiday. The local currency fell further on Thursday, losing 0.87% to R14.1385/$ by 6.50pm. As recently as June 7, it powered to a more than two-year high as it broke below R14/$.

“Apart from the Fed’s policy outlook, we think the favourable export backdrop, and how long this will last, will play an important role for the rand,” said Tilmann Kolb, an emerging markets analyst at UBS Wealth Management.

Having so far insisted to the market that it will keep rates at near-record lows to nurse the US economy through the effects of the pandemic, the Fed on Wednesday night signalled that it could raise rates twice in 2023, a year earlier than it had previously indicated, as the world’s largest economy gathers momentum.

Higher rates attract capital to dollar-denominated assets and have potential to push borrowing costs in emerging markets higher to provide potential investors a premium to compensate for the higher risk of holding those assets. That was reflected in local bond markets with the yield on the benchmark R2030 bond rising 17 basis points to 8.96%, the highest level since May 20. Yields move inversely to prices.

THIS WILL NOT NECESSARILY LEAD TO HIGHER INTEREST RATES AS THE DEMAND SIDE OF THE ECONOMY IS STILL TEPID

However, the rand was still about 4% stronger against the dollar so far in 2021 and 22% on a one-year view, according to Infront data. While Investec chief economist Annabel Bishop expects the rand to weaken to R14.35/$ by year-end, this is a far cry from the record low of R19.34/$ at the height of the Covid-19-induced volatility and will be just 0.7% weaker than it was at the start of 2020.

SA’s 10-year yield compares to 1.488% in the US and -0.2% in Germany, meaning it is still attractive to hold local bonds, a factor that may limit sales and provide some support for the currency. But, if yields rise on a sustained basis, it could have major implications for the government’s ability to fund itself and translate to more of the country’s wealth being diverted towards interest payments instead of key social services.

While “the surprisingly hawkish” Fed has negatively affected the medium-term outlook for the rand, this will not necessarily lead to higher interest rates as the demand side of the economy is still tepid, said Chantal Marx, head of investment research at FNB Wealth and Investments.

The Reserve Bank expects inflation to average 4.2% in 2021 and 4.4% in the next two years.