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Executive Summary
The rand continues to trade within our 14.00-14.50 range after Moody’s only brought out a regular update this week on South Africa’s credit and kept its rating unchanged at Baa3/Stable. Moody’s action also offset some rand weakness induced by Turkey in the broader EM markets.
We continue to target 14.00-14.50. Within this range, we believe that local and external risks are well reflected in the currency. As such, we continue to sell into rand strength on approaching 14.00 and buy into weakness on approaching 14.50.
The “dollar smile” framework: We use the “dollar smile” framework to visualise and contextualise the evolving macro-environment and the dynamics of the USD as it is the reserve currency of the world. Chart 1 is a visualisation of the “dollar smile” framework. Within the “dollar smile” context, there are three key points.
Point a: “Strong US economy” – The US’ economic growth is robust and outperforms that of the rest of the world, attracting capital flows favouring the USD. Added to this, the Fed’s hawkish monetary stance (inflationary pressures) favours further USD strengthening (and as a result, EM currency weakness – including the rand).
Point b: “Synchronised growth” – Global growth is synchronised. The US economy is growing, but inflation remains stable, and as a result, US monetary policy is neutral. This environment favours a weaker USD, along with low volatility, which bodes well for investors’ risk appetite. This also favours more risky carry trades (and as a result, EM currency strength – including the rand).
Point c: “Synchronised slowdown” – The US economy, along with the rest of the world, enters a slowdown; the Fed and other policy makers attempt to reflate the global economy by easing monetary policies. However, investors’ risk appetite wanes. De-risking by investors favours safe havens such as the USD, JPY and CHF. This comes at the expense of carry-trade strategies (and as a result, EM currency weakness – including the rand).
We believe the world economy is past point b and moving towards point c.
As such, in terms of a multi-month view, we believe the global economic cycle suggests one should consider a general weakening bias when dealing with EM currencies, including the rand.
When we consider the rand, we believe the currency has passed through the trough of the “dollar smile” curve (point b), and with the global economic cycle moving towards point c, the risk of a stronger USD and weaker rand is growing.
With the global cycle in mind, looking at local events, attention will no doubt move increasingly towards the upcoming general election in early May (08 May 2019). We would not be surprised to see rising volatility and a rand that trades closer to the upper band of our trading range, and even towards the 15.00 level.
