Foreigners are starting to show interest in South Africa’s portfolio assets again which can explain why the rand broke below the R14.70/$ mark to R14.64/$ on Thursday.
Foreign capital inflows to emerging market economies have significantly improved. Sentiment towards emerging markets improved significantly over November. Analysts say equities in emerging markets offer attractive valuations and considerable upside, particularly if the upswing in Chinese and Asian industrial activity continues to gather momentum.
One of the reasons for the positive sentiment is the roll out of vaccinations in advanced economies.
Investec Chief Economist Annabel Bishop said in a note that economic activity will return to normal as vaccinations start in the UK. Bishop said vaccination roll out coverage in advanced economies to the population is sparking optimism that the Covid-19 pandemic will be brought under control and normal economic activity will return.
She said as a result of this, commodity prices will continue to rise on market expectations of the global economic recovery in 2021.
“Such high levels of market optimism are driving very strong risk-on investor behaviour, causing emerging market currencies to strengthen on rising risk taking,” said Bishop.
Bishop said the economist commodities index shows prices rose by 25.3% year-on-year over November, 16.5% in October, and 13.8% in September, and a 15.2% price lift in July. This coming after a contraction over the first six months of the year.
“Metals’ commodities prices are seeing even more of a surge, up 37.9% year-on-year in November, after lifting 23.5% in October, 25.1% in September and 31.6% in August.
“The strong global financial market sentiment is heavily geared towards recovery, ignoring the rising cases of Covid-19 around the world as the Northern Hemisphere winter deepens, with markets geared instead towards good news,” said Bishop.
According to Nedbank, the rand is now effectively approaching its ‘fair’ value level. The bank said global forces are expected to be supportive of further rand appreciation, with rock-bottom interest rates in advanced countries.
“We still the think that bad news from the domestic front has been largely priced in, but the risks of further ratings downgrades remain high as both Moody’s and Fitch left South Africa on negative outlook. The next move down the ratings scale will hurt, with South Africa then joining Argentina and other nations notorious for chaotic defaults,” said Nedbank.
Nedbank added that even with the possible further downgrading, if global risk appetites remained robust, the rand will probably strengthen further in 2021.
The bank added that risk-on sentiment among global investors was the main driver of the rand’s continued recovery.
While this is good news, investors remain concerned about the surge in public debt burdens in developing countries.
In some emerging markets, the rise in government debt was caused and exacerbated by the pandemic, but in South Africa the trend was already well established prior to the pandemic.
This was caused by inappropriate fiscal policies, poor governance, rising corruption, political and social instability as well as disappointing economic growth.
The rand is still about 7.5% undervalued but the margin has narrowed substantially over November. If one allows for SA’s considerable structural imbalances and underlying inefficiencies compared with our trading partners, the rand is probably at or very close to fair value.
Further appreciation is likely over the short to medium, said Nedbank.