South African Rand Appreciation Dependent on Global Drivers says Goldman Sachs

- ZAR supported by global recovery
- Domestic headwinds to limit gains
- Market correction brewing says Market.com's Wilson

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The South African Rand can recover more of the ground it has lost in 2020 if global markets and commodity prices continue to appreciate say economists at Investec and Goldman Sachs.

The Rand is one of the worst performing major currencies of 2020 thanks to the coronacrisis which has only exacerbated dire domestic policies undermining the country's economy, but the currency's losses would be more substantial were it not for recovering global stock markets.

An ongoing improvement in U.S. and European markets, as well as global commodity prices courtesy of the Chinese rebound, continues to provide a much-needed source of support for the hard-up Rand, and this could continue in the near-term according to Annabel Bishop, an economist at Investec. "The rand ... continues to take its cue from international events, along with other emerging markets".

"The case for Rand appreciation depends on its high ‘beta’ to a continued global economic recovery, continued resilience of global trade, an eventual downshift in US-China trade tensions, and, most importantly for the USD/ZAR cross specifically, a continued weakening of the broad Dollar," says Zach Pandl, Economist at Goldman Sachs in New York.

While global factors are supportive, Pandl says domestic headwinds should continue to limit appreciation as "much of the Rand’s underperformance may be attributable to domestic factors, including disappointing activity data, and concerns around coronavirus management and the prospects for structural reforms."

Above: ZAR performance in 2020

South Africa on Monday night eased restrictions as covid-19 infection rates continue to move lower, which should take some pressure of the battered economy.

However, Goldman Sachs say a significant output gap in the economy should linger for some time and this will likely ensure inflation remains persistently below the South African Reserve Bank's inflation target of 6%.

Economists at the Wall Street investment bank expect inflation to persistently undershoot the target for the foreseeable future, potentially leading the SARB to cut an additional 0.50% in the first half of 2021 and to keep the policy rate on hold at a historic low of 3.0% through at least 2022.

"The Rand is also not unique in experiencing a 2020 cutting cycle that has eroded its real rate and carry: this dynamic has contributed to the broad underperformance of Emerging Market high-yielders since the late-March market trough," says Pandl.

Emerging Market economies tend to have higher interest rates at their central banks, resulting in higher bond yields and interest rates on cash deposits. This tends to attract significant inflows of foreign capital as global investors seek out higher yields which in turn provides demand for the domestic currency.

But cutting interest rates back tends to diminish this attractiveness to investors, particularly in countries where political uncertainty and economic troubles are growing. Therefore, lower rates for longer at the SARB will act as a headwind to the Rand.

Despite these domestic headwinds, Investec's Bishop says the Rand can yet drift slightly stronger over coming days "in the absence of any significant negative global market events".

The key risk to any Rand appreciation - given the international backdrop is its main source of support - therefore lies with the performance of global markets and whether recent optimism can persist.

The U.S. stock market - which the Rand has a high 'beta' to (close positive correlation) - has effectively recovered its coronacrisis losses.

But there are warning bells sounding says Neil Wilson, Chief Market Analyst for Markets.com, "the U.S. stock market is only at all-time highs because of the Fed and huge fiscal stimulus; it does not reflect reality."

Wilson says forward earnings multiples of ~25x for the S&P 500 are unlikely to persist while put-call ratios on stock options markets are moving in a direction that often correlates to a reversal.

Moreover, volatility futures point to investors expecting increased market volatility into the autumn as the U.S. presidential race inevitably tightens.

"Uncertainty over the result will create angst and volatility. The market is way too confident that Biden will win," says Wilson.