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The South African Rand's Rampahosa Rally Might Already be Done

The Rand's fortunes rest on whether Cyril Ramaphosa can get to grips with the ANC and wield enough influence to drive change in South Africa.

South Africa’s Rand has clung to December’s gains thus far in 2018 but analyst opinion remains divided over whether it will take another leg up in 2018, or about-turn and head south for the duration.

The currency avoided a potentially cataclysmic turn of events last year when, first, Moody’s held of on a downgrade of its local currency sovereign credit rating and, second, the reformist Cyril Ramaphosa clinched a narrow victory in the ANC leadership race.

It closed the year with a 10% gain over the US Dollar and retook lost ground from the Pound, Yen, Swiss Franc, Canadian Dollar and Australian Dollar. Hopes for the currency, as well as South African economy and politics, are now high.

“The constitutional court’s verdict last week initiated a process that might lead to the ousting of President Jacob Zuma,” says Elisabeth Andreae, an analyst at Commerzbank.

With current President Jacob Zuma dogged by corruption scandals over recent years, and an economy that has not long emerged from recession, much rests on whether Ramaphosa can wield enough influence to right a capsizing ship.

“Investors are viewing the possibility of Zuma being dismissed from office early, with the new head of the ANC, Cyril Ramaphosa, taking power and finally reforming the country, as a positive sign for the Rand,” says Antje Praefcke, another analyst at Commerzbank.

It appears reform cannot come soon enough, and waiting for Zuma's term to expire could be costly for the economy and the currency.

South Africa could still see its credit rating cut to junk, in February, if the next budget statement does not offer a credible plan for bringing down a budget deficit that is expected to have risen above 4% of GDP in 2017.

Moreover, without a reform of the nation’s politics and cleaner governance at state owned enterprises, international perceptions of corruption within the country are unlikely to change, foreign investment could lag and the economy might underperform.

“Even though this would strengthen the position of Cyril Ramaphosa his scope for action seems limited. Out of the six most important positions within the ANC only half support Ramaphosa,” says Andreae. “We remain sceptical regarding the current Rand levels.”

Ramaphosa may also find it difficult to get the two thirds majority required that is required on the National Executive Committee of the ANC in order to fully control the party. But not everybody is downbeat about the Rand or the South African economy.

“The ANC election-related 10% rally in ZAR has only taken the currency to around fair value on our DBeer metric, with the currency having reached 10-15% overvalued in previous appreciation cycles; thus, there is further room to rally on the positive factors,” says George Saravelos, a strategist at Deutsche Bank.

Saravelos forecasts improving trade flows, lower inflation and positive spillovers from Ramaphosa’s ANC victory into the macro and and fiscal arenas.

“We expect a decline in inflation for South Africa in Q1, driven by base effects, falling food inflation, and recent currency appreciation. Monetary policy meanwhile is expected to remain steady; thus, real rates should rise in Q1. Ex ante (Mar 18) real rates for ZAR are among the highest in Emerging Markets,” Saravelos writes in Deutsche Bank’s 2018 outlook.

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South Africa’s headline consumer price inflation is at 4.6% while its benchmark interest rate is currently at 6.75%, down from 7% before July 2017. This means a “real interest rate” of 3.15%.

Inflation is a crucial economic number for currency markets because it is price pressures that central banks are attempting to manipulate when they make changes to interest rates.

Interest rates themselves are the biggest draw for investors and currency speculators as government bonds, which are price off of them, are supposed to represent a risk free return.

“The trade balance has flipped from a deep deficit to a record-high surplus, mainly due to rapid export growth. In 12m rolling terms, the trade surplus currently stands at ZAR 80bn, compared to a deficit of ZAR 100bn just 2 years ago,” notes Saravelos.

The trade balance represents the difference between the amount of goods and services a country imports and the amount that it exports.

Countries that have surpluses sell more goods and services than they import, while a rising surplus signals strengthening demand for a currency.

“In particular, Q1 could provide a window of opportunity for EM FX, as the supportive factors remain in place while the potential risks are skewed towards the following quarters,” says Saravelos.

“US inflation is expected to remain subdued in Q1 due to base effects, and only forecasted to accelerate in Q2.”

US inflation is one of the greatest threats to the Rand as it could mean the Federal Reserve turns more hawkish and raises interest rates faster than markets expect.

This would be bad for the Rand as it would mean a stronger US Dollar and the South African currency has a negative correlation with the greenback.

“ZAR’s rally can transition from the sharp one in December (reaction around the ANC election outcome) to a more gradual one over the next few months,” the strategist forecasts.

Saravelos and the Deutsche Bank team recommend betting on a fall in the value of the US Dollar relative to the Rand, as a trading strategy for clients.

The Dollar was quoted 0.04% lower at 12.3516 against the Rand Tuesday while the Pound-to-Rand rate was down 0.52% at 16.7010.

Readers can learn more about what strategists think of the Rand's prospects in 2018 from; South African Rand: Compilation of Major Bank Forecasts, Currency Views for 2018.

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