More rand weakness ahead as the gap for rate hikes narrows

The rand could weaken substantially against the rampant dollar as the Federal Reserve (Fed) keeps increasing interest rates to tame red-hot inflation and South Africa’s economic growth stumbles.

US interest rates at their highest level since 2008 are increasing the appeal of dollar assets, given the higher return, and as investors chase the relative safety of American investments. An index measuring the greenback’s performance has rallied 19% this year, placing strain on emerging markets, which rely mainly on imports, and have accumulated high levels of dollar-denominated debt.

The only thing emerging markets can do now is to shore up their fiscal positions and engage in sustainable borrowing. It’s tough because most of these economies are already under pressure. You can only get that far by hiking in unison with the Fed before something breaks, so it’ll need to come from the fiscal side.

While South Africa is better off than most emerging markets because its borrowings are primarily in the local currency, the International Monetary Fund in October cut its outlook for gross domestic product growth for 2022 to 2.1% from a July estimate of 2.3%. It projected economic growth of 1.1% for 2023, from 1.4%. That’s slower than the emerging market average of 3.7% and forecasts for global output.

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The Reserve Bank pre-empted the inflation surge before major central banks, which wrongly predicted the upswing would be temporary, starting its rate-hiking cycle in November. Since then, it has raised rates by 275 basis points as inflation hovers near 13-year highs. The Fed has had to act more aggressively, raising rates by 300 basis points since March, with price gains close to 40-year highs.

You can’t keep hiking just because the Fed is hiking. We’re in a much different position from an economic point of view, a labour point of view, and a savings point of view.

The Fed is all about inflation. I can’t see the dollar turning around.

The rand has weakened about 13% against the dollar this year. According to data compiled by Bloomberg, the local currency hit a record closing low of 19.04 in April 2020. The rand could again test that all-time low or breach it if the economy slides into a recession and the dollar keeps strengthening.

Making money in turbulent times

There are still ways to make money.

Stocks and bonds have been hammered this year, with equities stuck in a bear market and fixed-income securities heading for one of their worst years. With little room to hide, investors should consider including alternative investments, which give fund managers more room to make returns when markets fall.

High and stubborn inflation, steep interest-rate increases, Russia’s invasion of Ukraine, rising food and energy prices, supply chain disruptions, China’s shutdown of its economy and its property crisis have contributed to the gloom.

A slowdown in global economic growth is raising concerns about a potential recession.

Volatility will continue to haunt markets as overvalued US stocks disappoint on earnings, interest rates continue their upward trajectory until inflation slows, and the dollar stays on its rampage. Novare collects funds from pension funds and other clients and then picks the best asset managers to manage the funds.

Alternative assets making ‘a killing’

You have to trade the volatility. The best way to do this is through alternative investments.

Alternative assets don’t’ fit the conventional equity, cash or bonds categories and differ by allowing hedge fund managers to take short or long positions in securities (bets that assets can fall or gain) or market-neutral funds (which seek to make above-average returns despite market conditions – often using products, such as derivatives that derive their value from an underlying asset like commodities, currencies, equities or interest rates). Macro hedge funds attempt to profit from broad swings in indexes caused by major political or economic events.

We are overweight alternative positions, and that’s been working well for us. All of our alternative managers are positive year-to-date.

Novare has been underweight equities and fixed income, meaning it holds less of the securities than benchmarks. It has started to see value in domestic equities, especially in stocks earning dollar income, while adding some bonds.

These conditions we’re going through now are allowing hedge funds to show their value. Over the past 14 years or so, with all the cash injected into markets by central banks, investors have assumed markets always go up. That’s not true.

Market-neutral managers returned 7% this year. Two managers who shorted US interest rates made a killing, while managers who called South African rate hikes did well. A macro fund is up 50%.

We have a diversified portfolio. I like to think of it as an ‘Armageddon Hedge.’ If the war blows out of proportion, volatility shoots up, stock markets plummet further and bond yields soar any higher, we’ll still make money.

Jacobus Brink is head of investments at Novare Holdings.