South African financial markets entered new difficult terrain yesterday, with the rand galloping towards the R20 mark to the US dollar following a rapid decline triggered by investor sell-off.
Foreign investors have been selling R11.4 billion in South African rand-denominated bonds in favour of safe havens such as gold. This rapid sell-off saw the rand breach the psychological R19-mark to the greenback for the first time in three years yesterday, reaching R19.29/$1 at 4 pm.
This is the lowest the rand has been since May 2020, and it has dropped more than 10% since the beginning of this year, implying that the rand’s purchasing power will continue to erode.
Traders are concerned that South Africa was raising interest rates slower than the US, causing the differential between South Africa and US interest rates to drop substantially during a risk-averse period, which has weakened the rand.
Nolan Wapenaar, co-chief investment officer at Anchor Capital, said the rand’s depreciation was caused by market participants taking underweight, and even a short position, against South Africa.
Wapenaar said these things tended to snap back when they correct, and larger swings in the rand were probably feasible when investors closed out their short positions.
Traders are concerned that South Africa is raising interest rates more slowly than the US, causing the interest rate differential between the two countries to narrow significantly during a risk-averse period, weakening the rand.
“Nevertheless, it is clear that the rand is oversold, though weak fundamentals will keep the local currency oversold and on the back foot for a while to come.
“It is plausible that the rand will again test the Covid-19 lows of R19.30/$1, but we maintain our view that the rand will likely end the year at R17/$1, though more negativity is possible in the short term,” he said.
The rand fell versus all major currencies and developing market counterparts like the Brazilian real, leading analysts to conclude that the weakness was due to domestic rather than global causes.
Investors are growing concerned about the country’s sluggish economic growth and the deployment of increased load shedding.
The country’s economy and productivity have suffered as a result of the protracted power crisis, which has resulted in supply chain interruptions, higher production costs, and, as a result, elevated inflation.
Eskom is implementing rotational power cuts lasting more than 10 hours per day, and severe outages are expected this winter due to the failure of some generation units.
The rand is under significant pressure due to the continued energy crisis, according to TreasuryONE currency strategist André Cilliers who also pointed to some momentum behind the sell-off, pointing out that foreigners sold about R7 billion in bonds on Wednesday.
“As they say, the trend is your friend, and we would need to see Eskom come out and give a detailed plan on how they plan to stop the electricity crisis The market is worried about stagnation in the local economy, and investors do not want to invest in a country with a poor short-term outlook,” Cilliers said.
According to analysts, the sad implication of the weaker rand is that it will force the South African Reserve Bank’s (SARB) hand when the Monetary Policy Committee (MPC) meets later this month to deliberate on interest rates.
The rand’s decline yesterday was remarkable because other emerging market currencies have been appreciating as the dollar has weakened.
This, according to Old Mutual Wealth investment strategist Izak Odendaal, showed that the market was penalising South Africa, notably for the deteriorating electrical situation. According to Odendaal, a lower currency would put additional upward pressure on domestic inflation, although the oil price had also been falling.
He also said, “The extent to which rand weakness results in higher inflation depends on how businesses pass on higher import prices. This in turn depends on whether these businesses feel domestic consumers can absorb the higher costs,” Odendaal said.
“What will stop the rand decline in the short term is further rate hikes, and it now seems clear Sarb will raise rates later this month. But unfortunately, this will further weaken the economy, much as load shedding does.”