Author: Hadyn Little (Foundation Fund Managers www.foundationgrp.co.za)
The Rand was stuck in one way traffic during 2015 as we lost approximately 30% of our value against the US Dollar. But, so far, 2016 has been more of a rollercoaster ride with pockets of Rand strength being countered by various setbacks, either through our own local doing (threats of arrest for Pravin Gordhan) or through international factors (plunging oil price, fears over China’s economic health, the list goes on).
Whether you are directly involved in an import or export business, or simply wanting to stay abreast of inflationary pressures as a result of Rand fluctuations, it is worth taking a look into the back half of 2016 and what lies in store for our beleaguered currency. I must however stress that this is not a prediction of what will happen to that Rand, but merely an assessment of events that could have a certain impact should they transpire.
While newspaper headlines will have us believe that its all doom and gloom for the Rand, in reality there are potential opportunities that will help us strengthen against the major currencies:
- Brexit is actually a risk and an opportunity given that the actual impacts of this unprecedented event will not be fully understood until it has run its course. As an opportunity Brexit has created huge uncertainty in the market, and the knee jerk reaction is for investors to run to “safe havens”, which include gold and gold shares. On Friday the 24th of June (the day after the UK referendum) R4.2bn of foreign capital flowed into SA in search of our bonds and gold shares, and over R22bn flowed in over the following week. This is the biggest weekly inflow since 2008 and demand for Rand based assets saw us surge from a low of R15.67 early on Friday morning to R14.84 by mid morning. Brexit is far from over, and as the UK and Europe muddle their way through some form of resolution we can expect the resultant inflow of investment capital as a result of uncertainty to boost the Rand.
- The Rand dances to the tune of interest rates in the US, with any increase in Dollar interest rates attracting investment capital away from Rand based assets and therefore weakening the Rand. A combination of mixed economic data coming out of the States plus global uncertainty following hurricane Brexit has meant that the FED has effectively removed any further interest hikes in 2016 from the table, and in fact there is a small chance of a rate decrease. The FED meets in mid July, September and December and should US interest rates remain unchanged, coupled with soft statements on future hikes then the Rand should strengthen at those points.
- Local inflation is already breaching the upper limit of 6% as set out by the SA Reserve Bank, with forecasts calling for 7.5% by year end. While unlikely given the Rand’s recent recovery, our Monetary Policy Committee has the ability to increase local interest rates by 25 basis points which will make Rand based assets more attractive to international investors, and the resultant capital inflows would drive the exchange rate down. As mentioned, this is an unlikely scenario which would probably only take place if the Rand crept up to the mid R16/$1 mark therefore threatening to escalate inflationary pressures.
- The final Rand “opportunity” is a bit of a long shot but worth mentioning none-the-less. In early June, Bloomberg switched their outlook on the commodities market from a bear to a bull run, this off the back of their commodity tracking index surging by 20% since January 2016. With stockpiles being depleted and supply constraints coming into play Bloomberg feels that a 4 year bear run could be behind us and commodity prices are set to increase. With Commodities making up 60% of our exports this would only be good for the Rand.
So the opportunities are out there, but risks are lurking as well:
- As mentioned Brexit is both a risk and an opportunity, and the risk portion is also market uncertainty. While investors move to safe havens in times of uncertainty they also exit riskier assets. So while our gold shares benefit the rest of the JSE gets sold off and these capital outflows cause the Rand to weaken. While this point might seem contradictory to the first “opportunities” point above I can guarantee you that the Rand would have faired much worse post Brexit if we had no gold shares on our local exchange.
- The 3rd of August sees our local municipal elections and if the violent scenes in Durban and Tshwane are repeated across the country, or if rigging is evident, then the international investment community will lose faith in South Africa causing the Rand to weaken.
- October sees Pravin Gordhan deliver the mini-budget with credit ratings agencies paying close attention to our GDP performance as well as concrete evidence of structural reforms pulling through from the main budget tabled in February this year. We have already seen GDP come under pressure since Feb, and any unrealised reform promises will weigh heavily on the Rand.
- On the 8th of November we have the US presidential elections and the race between Donald Trump and Hilary Clinton is too close to call. Depending on who you talk to both candidates will either be a massive success or failure so potential impacts on Rand are difficult to predict, but uncertainty is usually associated with Rand weakness.
- December sees the next round of credit rating agency reviews with an overwhelming consensus amongst economists that a downgrade to junk status by at least one of the agencies is a certainty. Pravin Gordhan pulled a rabbit out the hat by avoiding a downgrade in June, whether he can do the double in December remains to be seen.
So what does all this mean? In Foundation Fund Manager’s opinion, the risks to the Rand outweigh the opportunities, particularly in the longer term as a downgrade to junk status would take years to recover from. Given that there will be pockets of Rand strength over the next 6 months we advise that any importers use these to book forward contracts, and any investors use these to build their positions in hard currencies.