South African Rand Seen Lower into Fed Decision

• Rand vying for top spot among G20 currencies
• But USD/ZAR seen higher ahead of Fed decision
• SA CPI, SARB policy also key for ZAR this week

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The South African Rand eased lower early in the new week following a strong start to the year and some analysts say this is to be expected ahead of the January 26 Federal Reserve (Fed) monetary policy decision, the nearing proximity of which is potentially supportive of the Dollar.

The Rand ceded ground to a firming Dollar on Tuesday but its decline was limited and enough to enable the South African currency to edge higher against many of the other major currencies including Pound Sterling.

“It would seem that dollar strength is dominating currency movements. This strength seems to be driven by expectations that inflation will remain strong during 2022 and push the FOMC to raise rates,” says Siobhan Redford, a macroeconomist at Rand Merchant Bank.

“Next week’s Fed decision and accompanying statement will be critical in guiding markets on the committee’s expectations and concerns for the year,” Redford and colleagues also said in a Tuesday market commentary.

The South African currency still retained its position as the top performer among G20 currencies for the fledgling year, however, while Pound to Rand exchange rate losses for 2022 reached -2.2% as it slipped back beneath the 21.00 handle on Tuesday.

Above: USD/ZAR shown at daily intervals with selected moving averages and Fibonacci retracements of late November decline indicating possible areas of technical resistance to any further recovery.

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The U.S. Dollar rose against most counterparts on Tuesday, seemingly drawing a line under losses from the prior week, and the Rand Merchant Bank team has warned that it could remain an uplifting influence on USD/ZAR ahead of the next Fed decision on January 26.

“USD/ZAR has bounced from the 15.25 support level as rising US Treasury yields have capped EMFX gains. The 15.25-15.50 is the range to watch. We would look to buy dips in USD/ZAR close to 15.25 support if we get a chance,” says Yliya Yuliya Kryzhanovska, a trader at Credit Suisse.

While movements in the Dollar are influential, the Rand is also likely to be responsive to Wednesday’s release of inflation figures for December as these could impact market expectations for South African Reserve Bank (SARB) monetary policy and appetite for South African assets.

“Overall foreign inflows into South African portfolio assets this year so far total R3.0bn. This has supported the rand’s strength, along with easing monetary policy in the world’s largest emerging market economy. China’s first cut in its key interest (one year loan) rate since April 2020, of 10bp, occurred as its economic growth slowed, lifting sentiment for EMs,” says Annabel Bishop, chief economist at Investec.

Above: GBP/ZAR shown at daily intervals with Fibonacci retracements of September’s rally indicating possible areas of technical resistance.

Wednesday’s inflation figures are doubly important because prices in some financial markets have recently implied that investors are anticipating a lengthy series of interest rate rises that would lift the SARB’s cash rate by a total of 2% over the course of this year.

These are potentially misplaced expectations given the recent and ongoing weakness in some measures of South African inflation pressures.

Economists widely expect the annual rate of inflation to have risen from 5.5% to 5.7% in December, which would leave it near the top of the SARB’s three-to-six percent target band, although the more important “core inflation” rate is expected to remain at 3.3% and near the bottom of that band.

“The pandemic led to disinflationary trends in a few major EMs, all of them with double-digit unemployment rates. Inflation in Colombia, Egypt and South Africa during the pandemic was below the pre-pandemic trend, indicating a more consistent deceleration in price increases ahead,” says Luiz Eduardo Peixoto, an emerging markets economist at BNP Paribas.

The core inflation rate overlooks changes in prices of energy, food and some other items, which can all change for reasons unrelated to domestic economic momentum, and so this measure can sometimes be more influential among central bankers.

Should recent weakness in the core inflation measure persist it could eventually result in market expectations of the SARB being disappointed, which would be a likely headwind for the South African Rand.