Why the rand is the top emerging-market currency so far this year

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Over the last week the market likely started pricing in that SA rates will increase.
Over the last week the market likely started pricing in that SA rates will increase.
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  • The rand is so far in 2022 the strongest emerging market currency, according to TreasuryONE.
  • A recent rand rally has been surprising, given that the US Federal Reserve indicated that it may hike interest rates faster than previously expected.
  • The rand has found support in expectations that the Reserve Bank will also hike rates soon, as well as stronger commodity prices and a fairly quiet market.

This week, markets across the world were rattled by clear indications from the US central bank that it is going to hike rates, fast.

Minutes from the Fed's latest monetary policy meeting, which were released this week, showed that officials were concerned about inflation and confident about the US economy’s ability to take interest rate hikes in its stride.

"It may become warranted to increase the federal funds rate sooner or at a faster pace than participants had earlier anticipated," the minutes read.

This sent a shockwave through global markets, with shares selling off as investors considered the negative impact of higher interest rates on consumer spending and company debt levels.

It was also supposed to hurt the rand: the dollar will earn higher interest rates, which means that the rand would look less attractive in comparison.

Instead, the rand rallied. After trading above R16/$ earlier this week, it was last at R15.58.

Dollar/rand exchange rate over the past month. Source: XE

The rand strengthened against all expectations and is the strongest emerging market currency for 2022 so far, according to Wichard Cilliers, head of market risk and chief dealer at TreasuryONE.

You would expect a weaker rand ahead of aggressive interest hikes in the US, but the rand received support from other factors, says Citadel's chief economist Maarten Ackerman.

Chief among them is the expectation that the SA Reserve Bank will also hike rates fast, which the markets have started pricing in.

Ackerman says the bank made it clear that if the US hike interest rates, it won’t just stay put.

"I think market participants started pricing in that our local rates will also increase, given the guidance that the SA Reserve Bank gave [at the last MPC meeting], now that the Fed is turning more aggressive." The local bank’s next policy meeting starts on 25 January.

Furthermore, recent strength in commodity prices also supported the rand, Ackerman says. South Africa is an exporter of commodities.

After coming under pressure due to concerns about the impact of the new Omicron Covid-19 variant on global economic growth, the Bloomberg Commodity Index started to turn positive around mid-December. 

While Omicron seems more contagious, it looks as if fewer people are ending up in hospital. “Maybe as a result of that it is not going to be an economic calamity," says Ackerman. This bolstered commodity prices.

"Typically if we see stronger commodity prices, that is definitely supportive to emerging market currencies, especially the big commodity exporters like SA," he added.

Momentum Investments economist Sanisha Packirisamy agrees that markets seem to be pricing in a less harsh outcome from the Omicron variant relative to the prior Delta and Beta variants, which overburdened healthcare facilities and demanded a longer period of isolation and quarantine, affecting many economic sectors.

Bonds

The rand may also be receiving support from foreign investors buying local government bonds, says Cilliers.

Amid the Fed’s more aggressive interest rate stance, US treasury yields have jumped, with the 10-year yields up 22 basis points over the past week.

"Normally this will coincide with some weakness in the local currency, but we suspect that the local SA government bond yields are still very attractive for foreign investors. We saw holdings for foreigners of our bonds decline in recent times and perhaps there has been some yield-seeking by foreigners this week," he suggests.

On Friday, disappointing US employment data were also released, which Packirisamy says could soften expectations for a sooner-than-expected increase in US interest rates. This is rand positive.

In addition, she believes that the rand strength could have been amplified by trading volumes that are still lower than normal given that local market participants are still on leave.

"The USD/ZAR market remains fairly illiquid as we await everyone's return to work next week."

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