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The South African Rand was little changed on Tuesday having recovered from last week's sell-off but may lack direction until after Wednesday's Federal Reserve (Fed) decision, which has implications for global borrowing costs and especially those in emerging markets.
South Africa's Rand was a fraction higher against the Euro and many other European currencies including Pound Sterling on Tuesday while trading a touch lower against the U.S. Dollar and its North American counterparts like the Canadian Dollar and Mexican Peso.
This was despite tepid declines in oil prices this week, coming in the wake of an earlier sell-off that had been driven by surging U.S. government bond yields that act as the closest thing to a global 'risk free' rate and are always an important consideration for investors in developing economy bond and currency markets.
"The rand rapidly returned below R15.00/USD, after reaching R15.57/USD early last week, today running closer to R14.80/USD and with the volatile domestic currency averaging R14.99/USD for this quarter so far," says Annabel Bishop, chief economist at Investec. "While market appetite for risk has returned, including perceived extremely risky investments such as the portfolio assets of South Africa and Turkey, this will not necessarily persist."
Low-yielding European currencies were most out of favour on Tuesday and even in a session that brought mixed fortunes to risk assets, with stock markets mostly higher across the globe while commmodity prices including those of industrial metals were mostly lower.
Source: Investec Bank.
"The rand continues range-bound trading as it struggles to find momentum and any real direction," says Bianca Botes, an executive director at Citadel Global.
These patterns could continue ahead of Wednesday's Fed decision, due at 18:00 London time, given its implications for the Dollar.
The Dollar was lower against many counterparts on Tuesday but had previously been charged up by U.S. bond yields that have risen back to pre-pandemic levels, aided by an improving growth outlook.
Investors and currencies will look for the Federal Reserve to either indulge or pour cold water over recent speculation that a brightening outlook for the U.S. economy could lead the bank to end its $120bn per month quantitative easing programme early and begin lifting interest rates as soon as next year.
"While FX markets were tethered to the firming global equity risk mood in 2020, this year has its own script: a) higher yields are pressuring emerging market currencies more than developed currencies, unless you are an oil-exporter; and b) economies where yields are rising just as quickly as the US and where growth expectations are firming have better appreciation prospects than others," says Richard Franulovich, head of FX strategy at Westpac. "USD and GBP have notably strong credentials in this environment, but these dynamics could shift if and when Europe gets her vaccination act together."
Source: Deutsche Bank.
"The dollar has been recently supported by market pricing Fed hikes as soon as next year. Our baseline view of a Fed on hold well into 2023 is likely to see greater pressure on the dollar returning via this market pricing not being realized, deteriorating external account and negative real yields," says George Saravelos, head of FX strategy at Deutsche Bank. "Beyond this baseline, risks abound and the threat of greater volatility in FX is substantial."
Fed policymakers have said repeatedly that their average-inflation-targeting framework means they want above-target inflation manifested in actual outcomes rather than simply envisaged in forecasts and market expectations, before they lift interest rates. But investors have kicked sand into the eyes of the bank and notably since President Joe Biden's $1.9 trillion stimulus pack began to look as if it might clear a congressional gauntlet with only limited surgery from financially conservative lawmakers.
"Rhetoric underlining that the Fed wants to stay the course for now and that any strong inflationary pick-up is seen as likely transitory means that we are very unlikely to see any strong upward revision in policy forecasts in the dot plot," says John Hardy, head of FX strategy at Saxo Bank. "A few more Fed members shifting to a 2022 lift-off forecast and several more suggesting that 2023 is in play could impress the market and send the US dollar and US yields higher."
It remains to be seen what the Fed will do about this but it has form for acting 'dovish' even when all is looking up for its economy. Notably, forecasts for the economy were improving, the job market had bottomed out and inflation expectations had recovered the bank's 2% target when in November 2009 the FOMC announced what was then only its second ever quantitative easing programme. The Dollar would likely suffer and the Rand benefit from any repeat performance or other 'dovish outcome this week.
Above: USD/ZAR shown at weekly intervals with GBP/ZAR (purple) and 10-year U.S. government bond yield (blue).
The outcome of the Fed meeting in terms of whether or not it provides a further lift to the Dollar and Washington's bond yields is the highlight of the week for the Rand, but January's retail sales data due from South Africa on the same day will also likely be given a look-in by investors seeking clues on the damage caused by a second imposition of restrictions on social contact which had largely been reversed by late February. Consensus favours a -2.4% year-on-year fall.
"The global backdrop is arguably supportive of gains in both the rand and local bonds, but much depends on how US treasury yields are priced throughout the day," says Nema Ramkhelawan-Bhana, head of research at Rand Merchant Bank. "Our FI analyst, Kim Silberman, asserts that if markets favour risk, the rand could rally to 14.50 against the greenback."
South Africa's Rand is one of the most susceptible among emerging market currencies to rising borrowing costs in the U.S. due mainly to the country's long overburdened public purse, which has seen the country's credit rating downgraded to 'junk' and regularly requires Treasury to perform budgetary acrobatics in order to keep overseas investors satisfied that sufficient efforts are being made to right the public finances.
Finance Minister Tito Mboweni told parliament last month that government debt is now expected to stabilise at 88.9% of GDP in 2025/26 before declining thereafter, which is an improvement on the outlook as it stood at the time of October's medium-term budget plan. The October 2020 outlook was for debt-to-GDP to top out at 95.3% in 2025/26, which was also the point at which the primary budget balance was expected to move from deficit to surplus.