The value of the rand could exceed and strengthen to nearly 11 per US dollar, mainly due to buying local bonds overseas to benefit from high yields and record prices for many locally produced commodities. Daniel King, Head of Fixed Income Counterpoint Asset Management, expressed this view during a webinar.
“The rand outperforms the basket of currencies of our trading partners. Counterpoint has an internal purchasing power parity (PPP) model that suggests a fair value of 13.50. This is based on the price and inflation differentials in South Africa compared to other countries, ”he added.
Commodity prices, which boost South Africa’s terms of trade, are a key factor in the strength of the rand.
“As long as the long end of our bond curve is relatively attractive, it will attract capital inflows, which could further strengthen the rand,” King said.
Listen / Read: What Stimulates the Rand?
“ The rand is going up and down. It can exceed by about 20% at the higher end of the PPP level. So if you think the rand is just around 13.50 it might even hit the 11 lowest against the US dollar, ”he said.
In an interview after the webinar, he said that was not Counterpoint’s basic point of view.
“You shouldn’t be surprised if it goes over 20%. Historically, he went even further than that. The reason this is even more likely than history is mainly that real interest rates are extremely high in South Africa, ”King said.
“In the United States, the ten-year government bond yield is less than 2% while you get 9.5% on a South African government bond yield for a similar rate of inflation. This type of real interest rate spread is a powerful carry trade attraction for global capital flows. It is very plausible that short-term capital flows will continue to strengthen the rand just on this basis, ”he said.
‘I see little standing in the way of [the rand going to 11 to the US dollar]. If there is a shock at the global level, it creates a kind of risk-free situation that could reverse it, ”King said.
The rand has strengthened 20.6% to 13.81 over the past year, an average appreciation of just over 1.7% per month. The last time the rand was listed near 11 to the US dollar was in 2014.
King believed that the peak in local inflation was likely transient. Beyond rising food and gasoline prices, the rand is likely to keep a lid on imported inflation.
He said he would be surprised if the South African Reserve Bank (Sarb) would raise interest rates as aggressively as the money market does, which is almost a percentage point next year.
“ Given the weakness of the underlying economy, they [the SARB] can afford to let inflation temporarily exceed. If the rand goes over and goes to the lower 11, there will be no rush to do so [hike rates]. This will likely reflect a strengthening of the bond market due to improving public finances ”.
Banks, retailers benefit
He said if the rand strengthens significantly, domestic companies with high debt, such as banks and retailers that sell goods on credit, would benefit. Investors holding local bonds would benefit from lower local yields.
“The portfolios that are going to hurt are those that are overly exposed to offshore assets.”
This article first appeared on Citywire South Africa here, and republished with permission.