South African Rand Can Go Higher on Supportive EM-Friendly Backdrop

- ZAR forecasts raised at Commerzbank
- BlackRock back Emerging Market assets
- Key risk to ZAR is accelerated Fed tightening

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A benign global investment backdrop is the main engine behind recent advances in the value of the South African Rand, and this support is expected to remain in place for some time yet say analysts.

The South African Rand has advanced against all the major G10 currencies and the majority of its Emerging Market peers over the course of the past week as its recovery from earlier 2021 lows accelerates, with only the Mexican Peso having put in a stronger performance.

"The current EM-friendly market environment with ample liquidity, in which economic optimism and risk-on sentiment prevail, offers the rand further appreciation potential," says Elisabeth Andreae, FX and EM Analyst at Commerzbank.

Above: Rand gains against the world's major currencies over the past week. 

Gains in the Rand come despite ongoing concerns about South Africa's domestic picture, where issues surrounding governance, policy and a bloated state apparatus provide headwinds to economic growth.

Nevertheless, the domestic picture is stable enough to allow foreign investors to maintain exposure to South African assets which offer greater yield than their Developed Market counterparts, particularly during times of positive global investor sentiment.

"The rand is benefiting from the prospect that, with (global) vaccination progress and the global economic recovery gaining momentum, the South African economy will also be able to regain more ground from the second half of the year at the latest," says Andreae.

The Dollar-Rand exchange rate opened 2021 at 14.68 before going higher to 15.57 in early March, however a rapid pace of appreciation by ZAR has since seen the pair tumble back to present levels at 14.25.

"The rand recovered noticeably and faster than we had expected," says Andreae.

Above: Rand gains against a host of Emerging Market currencies.

The Pound-to-Rand exchange rate opened the year at 20.06 before jumping to highs at 21.51 on March 08, the Rand rebound has since pressured the pair back to 19.84 where we find it now.

Owing to the scale of the Rand's rebound and expectations for the global backdrop to remain supportive, Commerzbank tell clients they are raising their forecasts for the currency.

"The rand should fundamentally benefit in the wake of the global recovery," says Andreae.

Analysts at BlackRock, the world's biggest asset manager, have meanwhile said they continue to like emerging market assets in their portfolios.

In a research briefing out this week, BlackRock says the economic restart and greater stability in U.S. government bond yields should support Emerging Market (EM) assets over coming months.

The Dollar rallied through January, February and March as the yield paid on U.S. Treasury bonds rose, particularly on bonds dated over 5 years in duration.

The rising yield reflected expectations that the U.S. Federal Reserve would have to pull the brakes on its hugely supportive monetary policy sooner rather than later, which in turn raises the cost of finance not only in the U.S. but across the world.

The Rand is therefore highly vulnerable to such a move by the Fed, but most economists are of the view the Federal Reserve will keep to its word and only consider raising interest rates beyond 2022 and therefore allowing for a supportive backdrop for EM assets.

"U.S. Treasury yields and the U.S. dollar are key drivers for EM assets," says Wei Li, Global Chief Investment Strategist at BlackRock Investment Institute. "We see greater stability in yields and in the U.S. dollar over coming months."

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Analysts at Commerzbank say a key risk to their expectations for a stronger Rand are that the Federal Reserve brings forward the timing of its monetary tightening policy - which would likely take the form of a 'tapering' of its quantitative easing programme, and then interest rate rises.

"The tide is likely to turn for the rand with recurring Fed tapering expectations. The economy and the currency remain vulnerable, especially if global risk aversion picks up again or if the environment for EM currencies becomes gloomy in the wake of rising G10 yields," says Andreae.

But BlackRock say the current environment is however likely to persist for long enough to allow investors to increase exposure to EM assets.

"We expect the rise in the dollar to take a pause as markets start reflecting expectations for the reopening to broaden out, easing some pressure on EM assets," says Li.

"We stay overweight EM," she adds.

Commerzbank forecast the U.S. Dollar-Rand exchange rate to reach 14.50 by the end of June and 14.00 by the end of 2021.

Given their forecasts of 1.34 and 1.37 in Pound-Dollar for the respective timeframe, the forecasts for the Pound-Rand exchange rate cross are approximately 19.45 and 19.18.