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The South African Rand (ZAR) is poised for continued strength, according to a new report by Walter De Wet, an analyst at Nedbank.
The bank maintains a bullish outlook on the Rand, projecting a fair value range of 17.00 to 17.25 against the US dollar, with broader trading expected between 17.00 and 18.20.
A key factor underpinning Nedbank’s optimistic forecast is the high real yield differential between South Africa and the United States. While South Africa’s current account deficit, at -1.0% of GDP, might typically weigh on the currency, the real yield differential of 3.5% in South Africa’s favour more than compensates.
According to the report, the Rand strengthens by approximately 15 cents for every 100 basis points (1%) of favourable real yield differential, offsetting the negative impact of the current account deficit.
"With a smaller current account deficit and lower inflation expectations, our estimates suggest that South Africa’s (SA’s) real bond yields are high enough to mitigate the risk of currency weakness that may be induced by foreign portfolio flows. This, in our view, will continue to favour an environment where rand weakness fades. This would be consistent with our underlying fundamental view that pins our fair-value range at 17,00 to 17,25. We maintain our bullish bias for the currency, with the rand above this range," De Wet states.
"Lower inflation and a smaller current account deficit have further contributed to rising real bond yields, supporting the Rand," De Wet notes. The recent drop in inflation to 2.9% has bolstered real yields, even as the South African Reserve Bank (SARB) is expected to cut interest rates in 2024 and 2025.
Economic and Market Outlook
Nedbank’s report highlights several macroeconomic and market forecasts:
- GDP Growth: Expected at 1.0% in 2024 and 1.6% in 2025.
- Inflation: Average CPI is forecast at 4.5% in 2024 and 3.8% in 2025.
- Interest Rates: The SARB is anticipated to reduce rates by 50 basis points in 2024 and another 50 basis points in 2025, bringing the repo rate to 7.25% by the end of 2025.
- Bond Yields: Fair value estimates for South Africa’s 10-year and 30-year bond yields are 10.3% and 11.6%, respectively, while the US 10-year yield is projected at 3.9%.
Balancing Deficits and Yields
While South Africa’s current account deficit typically weakens the Rand by around 15 cents per percentage point, the strong real yield differential more than offsets this impact.
“Our estimates would suggest that this real yield differential is more than enough to offset the negative impact of the current account. In fact, the real yield differential is high enough that it favours rand strength rather than weakness. This would be consistent with our underlying fundamental view that pins our fair-value range at 17,00 to 17,25. We maintain our bullish bias for the currency,” De Wet explains.
Nedbank highlights that foreign inflows, attracted by high real yields, are crucial in funding the deficit and supporting the currency.
“Our fair-value range for the rand remains at 17,00-17,25. For now, we favour a period of consolidation in the currency within a broad trading range (Read “Rand at target level; history favours momentum” dated 27 September),” De Wet adds.
The report underscores that the SARB’s anticipated rate cuts may have limited impact on long-dated nominal bond yields, which remain influenced by fiscal policy. This dynamic allows real bond yields to rise, further strengthening the Rand.
Outlook for USDZAR
“We maintain our strategic and fundamental bias for a stronger rand and believe momentum continues in that direction,” De Wet emphasises.
Nedbank concludes that the Rand’s bullish trajectory will likely persist, with expectations for eventual consolidation within the 17.00 to 17.25 fair value range. "Our fundamental neutral range for the USDZAR is between 17,00 and 17,25. We expect a period of consolidation in the currency around our fair-value range. Our bias remains for an eventual break lower in the USDZAR,” De Wet states.
As South Africa navigates the interplay between real yields and structural deficits, the Rand’s resilience serves as a testament to the importance of yield differentials in global currency markets.
An original version of this article can be viewed at Pound Sterling Live