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Counterpoint: The rand could overshoot and strengthen to 11 to the US dollar

If the rand strengthens significantly, domestic companies with high leverage, like banks and retailers, will benefit.
Image: AdobeStock

The rand’s value could overshoot and strengthen to near to 11 to the US dollar, mainly because of foreign buying of local bonds to benefit from high yields and record prices for many locally produced commodities. Counterpoint Asset Management head of fixed income Daniel King expressed this view during a webinar.

Outperforming

“The rand is outperforming the basket of currencies of our trading partners. Counterpoint has an internal purchasing power parity (PPP) model that suggests a fair value of 13.50. That is based on price differentials and inflation differentials in South Africa versus other countries,” he added.

A key factor driving rand strength is commodity prices, which are boosting South Africa’s terms of trade.

‘As long as the long end of our bond curve is relatively attractive, that will attract capital inflows, which could further strengthen the rand,’ King said.

Listen/read: What’s boosting the rand?

Overshoots 

‘The rand overshoots to the upside and downside. It can overshoot by 20% or so on the stronger end of the PPP level. So if you think the rand is fair around 13.50, then it could even go to the low 11s against the US dollar,’ he said.

During an interview after the webinar, he said that this was not Counterpoint’s base case view.

‘You shouldn’t be surprised if it overshoots by 20%. Historically, it has gone even wider than that. The reason it is even more likely than history is primarily that real interest rates are extremely high in South Africa,’ King said.

Consumer inflation 

‘In the United States, the ten-year government bond yield is below 2% while you are getting a 9.5% on a South African government bond yield for a similar rate of inflation. That kind of real interest-rate spread is a powerful carry trade attraction for global capital flows. It is very plausible that short-term capital flows will continue to strengthen the rand just on that basis,’ he said.

‘I see little standing in the way of [the rand going to 11 to the US dollar]. If there is a shock globally, that creates a kind of risk-off situation that could turn it around,’ King said.

The rand has strengthened by 20.6% to 13.81 over the past year, or an average appreciation of just over 1.7% per month. The last time that the rand was quoted close to 11 to the US dollar was in 2014.

Interest rates 

King believed that the spike in local inflation was probably transitory. Beyond the rise in food and petrol prices, the rand would likely keep a lid on imported inflation.

He said that he would be surprised if the South African Reserve Bank (Sarb) hikes interest rates as aggressively as the money market is pricing in, which is almost a percentage point over the next year.

‘Given the weakness of the underlying economy, they [the SARB] can afford to let inflation overshoot temporarily. If the rand overshoots and goes to the lower 11s, there will be no rush to do that [hike rates]. It will probably reflect a strengthening bond market because of improving government finances.’

Banks, retailers to benefit

He said that if the rand strengthened significantly, domestic companies with high leverage, like banks and retailers that sell goods on credit, would benefit. Investors holding local bonds would benefit from the decline in local yields.

‘The portfolios that are going to hurt are those that are overly exposed to offshore assets.’

This article was first published on Citywire South Africa here, and republished with permission.

COMMENTS   12

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The overshoot already happened. You are way too bullish. The reasons you mentioned have already been discounted, that is why the rand appreciated from R19,30 at the peak last year to current R13.80 level (-28%). I firmly believe the opposite will happen because of an imminent global shock. Technically, the rand could strengthen to R13.50 in the next week or so (bottom level of a double top on weekly charts).
Furthermore, the rand should not be at fair value, based on poor local economic and political conditions. We should not forget that SA government debt has a junk credit rating by all 3 rating agencies and the previous time the rand reached R11/R12, this was not the case! So, why has the rand rallied so much? Firstly, because of a weaker dollar over the last year. Secondly, the interest rate differential attracting foreign capital inflows. Thirdly, cheap money flooding global fin markets. When the global shock happens, as a result of inflation fears, foreigner will pull their money from EM countries. Gold and the dollar will become the safe havens and we’ll see a quick and sharp USD/ZAR depreciation.

Not if there is an absolute blow out of the USD.

30% more Dollars printed since January 2020 that is why PGM(s) are going up, then more Dollars for ZAR(s).

Oh and don’t forget inflation, serious inflation coming up then interest rates go up and up and up

I think (if I read you correctly), you’re saying the same factors are at okay… But they’re far more optimistic about the rand.

Time will tell I suppose, but in the longer term – as you suggest – our meagre economy and poor politics will take it’s toll.

If people rush to gold, the Rand will benefit. The dollar is weak during periods of inflation, the US has to import most of their consumption and is running a massive trade and budget deficit. So I think you overestimate the draw of the dollar. Inflation is not a financial crisis…. where everyone simply rushes to the dollar.

Thats exactly what its about.

Where are all the Rand bears now!

I have been predicting a Rand recovery to 13, especially after the Junk rating was confirmed.

Yield has always been, and will always be king. I early my FX trading days, the DEM with the 10 Year German Bund yielding more than 10 %, the Mark was King.

The QE in the US, with trillions of US Dollars lying at the FED, at Zero % yield, will keep the US Dollar down, hence high yielding emerging market currencies will attract funds. The Chinese virus has brought African economies to a survival mood – no capital expenditure will take place for many years to come – imports will drop dramatically and vital exports will continue to flow into China.

The Dollar/Rand will always be and has always been, a fluctuating currency, depending on big import and export orders – it’s an ”order” market!

The rand is far too undervalued and should be much stronger. Our country is much better than many other places in the world! Countries print currency and have much larger debt and yet they are stronger. It’s the biggest joke! The rand should be under R10 to the dollar! South Africans are brilliant and dynamic and we will get stronger than the R10 mark!

Yes and No.

Yes – South Africans are brilliant and dynamic.
NO – Our Government is atrocious, corrupt, incompetent,Communist, etc

You see, in the real world, Government matters, policy matters more than how nice the population is. The fact of the matter is the ANC destroying our economic prospects and the exchange rate is a reflection of that.

The exporting of long-term internal wealth to short-term foreign speculators continues unabated as if nothing ever happened in South Africa.
No one asks about the interest rates being offered or where the ability of South Africa to service the carniverous foreign trough of wonderous rates is sourced. Not ever. Never. It is just accepted as an indigenous money tree instead of an unnatural and imposed burden for the long-term foreign benefit.

The real interest rate differential between SA and the USA is 10%. That implies that no sane investor will borrow and invest locally, while they will do so in the USA where the real rate is negative 4%. Only bond investors are keeping the rand strong and bond investors are “gold diggers”, they leave you the moment you run out of cash flow.

Here’s a radical thought: Instead of all the mumbo-jumbo about inflation rate differentials and trade balances, let’s look at the person in the street who has to scrape out a basic existence – each country’s legislated minimum wage?
The Federal rate in the USA is $7.25 per hour. In South Africa the legislated minimum is R21.69.
21.69/7.25 = 2.99, so instead of a current exchange rate of 13.78 we should be looking at 13.78/2.99 = 4.61.
Few Moneyweb readers will accept that because it might be too close to reality.

End of comments.

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