The South African Rand is Seen Topping Out as Narrow Range Forecast to Prevail into Year-end 

- ZAR outperforms major & EM rivals in fourth week of gains.
- As vaccine and recovery hopes lift risk assets, USD bleeds.
- But is peaking, USD/ZAR seen averaging 17 into year-end.

Image © GovernmentZA

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The Rand advanced on the Dollar and Pound Friday, leaving it on course for a fourth consecutive week of gains over major currencies but the South African unit is close to topping out, according to some analysts, with narrow ranges seen prevailing into year-end. 

South Africa's Rand was again an outperformer on Friday having risen against all major counterparts except the Swedish Krona, as well as its ten largest emerging market rivals as steady appetites for risk enabled stock markets and positively correlated currencies to creep higher into the weekend. 

Friday's performance is a strong finish to a fourth consecutive week of gains by the South African currency, which has followed stocks and commodities higher as investors continued to overlook new records for coronavirus infection numbers in South Africa, the U.S. and the world at large.

The still-growing pandemic has fallen by the wayside where once it was an outright headwind to risk appetite, something that would also be mostly true of rising tensions between the U.S. and China. 

"With the S&P 500 now just 5% below the record high in February, investors may need confirmation on vaccines or policy support to advance further," says Derek Halpenny, head of research, global markets EMEA and international securities at MUFG. 

Above: South African Rand performance on Friday. Source: Pound Sterling Live.

Investors have shown a clear preference for the grass on the side of the coronavirus crisis, betting all week that a vaccine will become available soon enough to see off the pneumonia-inducing disease and facilitate a global economic recovery. Monetary policy medicine and building hopes of a swift recovery have been key to lifting risk assets off their March lows and the latter was bolstered this week when Moderna and Oxford University reported trial results that were widely described as positive.

But a vaccine remains a long way from the production line and even then there's uncertainty over how quickly it could be produced in sufficient quantity to meet demand from the world's coronavirus hotspots. Meanwhile, investors still don't know the extent of the damage caused by national shutdowns in the second quarter, much less the degree to which economies rebounded toward the end of it and in July as restrictions were eased. Investors will be deep into the final quarter before those numbers materialise. 

"Range trading is the order of the day, despite a record number of single-day covid-19 fatalities being recorded locally. In isolation, the covid-19 numbers have had little bearing on the rand market thus far, with participants’ interpretation of its socioeconomic impact providing greater steer. All the while, the National Treasury remains mum on its role in the financing of SAA," says Nema Ramkhelawan-Bhana, an economist at Rand Merchant Bank. 

Above: USD/ZAR rate shown at daily intervals alongside S&P 500 (orange line).

South Africa is now among the world's coronavirus hotspots after having risen through the global league table due to explosive growth in infections during July, which has seen the total number more than double from 159k to 324 on July 16, although the mortality rate implied by official disclosures is just 1.49%. The Rand has overlooked the increase as well as Sunday's retightening of restrictions on activity that saw alcohol sales banned and a nighttime curfew imposed. 

Ramkhelawan-Bhana says the outcome of a dispute over a bailout for South African Airways could have an impact on the local bond market and as a result, the Rand. Finance Minister Tito Mboweni is reported to have agreed R10.1bn (£480 million) of unbudgeted expenditure, which is a paltry amount in GDP terms but would nonetheless be a bad message to send to a bond market that was only just recently perked up by Mboweni's pledge to produce a primary budget surplus by 2023/24.

"The search for yield should continue to benefit EM assets in the second half of 2020. However, due to domestic fiscal risks, we expect USD/ZAR to trade above its fair value, around a mid-point of 17.00 over the next few months, rallying to below 16.50 on positive global surprises and selling off towards 17.50 in response to global uncertainty," says Kim Silberman, a currency economist at Rand Merchant Bank. "If growth in China remains supportive of commodity prices, as we expect, then USD/ZAR is likely to end the year at 16.50 despite the event and other risks between now and December." 

Above: USD/ZAR rate shown at daily intervals alongside South African government 10-year bond yield (orange line).

USD/ZAR has recently had a positive correlation with the 10-year bond yield, which would rise in the event of unplanned expenditure or worse-than-anticipated economic data that are seen subjecting investors to additional credit risks. Yields have an inverse relationship with prices so when the real-time borrowing cost rises, it's because bonds are being sold and prices are falling. 

South Africa's credit rating was downgraded to 'junk' at Moody's in March, leading to an April expulsion from the FTSE World Government Bond Index that some of world's big fund managers seek to benchmark to. The downgrade has shrank the pool of investors who're eligible to buy South African government bonds and in the process, help finance the country's budget. But absent events with adverse credit implications the Rand is forecast to continue trading in lockstep with the ebb and flow of global risk appetite, which is best reflected in the performance of stock markets and notably, the U.S. S&P 500.

Other short-term influences include the outcome of talks aimed at finding a compromise over the European Union's €750bn economic recovery fund, talks that continued on Friday. Any compromise agreement that paves the way for the EU Commission to begin doling out grants and loan guarantees from January 2021 would lift the Euro-to-Dollar rate and in process, provide support to emerging market currencies including the Rand. 

Above: Pound-to-Rand rate shown at daily intervals alongside South African government 10-year bond yield (orange line).