South Africa VS Coronavirus: Rand driven up by global risk appetite

This is part 1 of a series.

Africa’s most liquid currency has recovered to 17.25 rand versus the US dollar, since hitting a low of 19.35 in April.

The recovery has been driven more by risk appetite for emerging markets than by country-specific issues, says Peter Takaendesa, head of equities at Mergence Investment Managers in Cape Town.

That risk appetite could vanish at any moment. According to South Africa’s Bureau for Economic Research on June 8, the global recovery is risk assets is seen by some as “the most hated rally in history.”

READ MORE South Africa Rand to pick up soon as central banks create new money

The market rebound “seems so far removed from the economic reality, most notably projections of a depression-like contraction in global GDP during 2020”, says the bureau, which is based at Stellenbosch University.

According to the “Big Mac Index” invented by The Economist in London, the rand in January was the weakest currency in the world.

• The index is based on the idea of purchasing-power parity, which holds that currencies should converge at levels which allow the same basket of goods to be purchased for the same price everywhere.
• Based on the price of a Big Mac, The Economist found, the rand in January was 62% undervalued against the dollar, cheaper than any other currency measured.
• Yet global stock markets and risk appetite were still healthy then: the rand was clearly being driven down by the relentless poor economic news out of South Africa.

COVID-19 has changed that dynamic. South African events will have little influence over the currency in the short to medium term.

• “We believe that global investors realise that a number of issues that local investors believe to be unique to their own countries are actually quite common in many other related emerging markets.” says Takaendesa.
• He expects increased volatility in the rand and related emerging markets currencies until there is a sustained recovery in the global economy.

Carry Trade

It’s a “mistake” to think of South Africa in isolation from other emerging markets currencies, says Guillaume Coutant, CEO at Emvest Partners, which advises financial institutions on emerging markets, in Paris.

Local monetary policies have only a limited impact on the rand in the context of a global crisis, he says: the direction of US dollar and US Federal Reserve policy are much more important drivers.

Flows into emerging market currencies, Coutant says are influenced by the carry trade – borrowing money at low interest rates in one currency and then investing it in a currency with higher-yielding assets.

• Due to COVID-19, all emerging-market countries have cut interest rates, limiting the amount of carry-trade available. That means that investors need currency appreciation to replace carry-trade yield, he says.

This has provided some support for the rand, seen as likely to strengthen if the global economy recovers from COVID-19, says Coutant .

But if the COVID-19 newsflow worsens, those positions will rapidly unravel, he adds.

• The rand is “one of the most volatile currencies,” Coutant says. “It’s the first to be wrecked when there is bad news.”

READ MORE Coronavirus: South Africa expects economy to tank as it grapples with pandemic

According to Takaendesa, that means the safest course is to avoid buying the rand for now.

Bottom line:  Investors should watch global risk appetite rather than South African news flow when assessing whether to raise or cut rand exposure.

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