Counterpoint: The rand could overshoot and strengthen to 11 to the US dollar

The rand’s value could overshoot and strengthen to near to 11 to the US dollar, mainly because of foreign buying of local bonds to benefit from high yields and record prices for many locally produced commodities. Counterpoint Asset Management head of fixed income Daniel King expressed this view during a webinar.

Outperforming

“The rand is outperforming the basket of currencies of our trading partners. Counterpoint has an internal purchasing power parity (PPP) model that suggests a fair value of 13.50. That is based on price differentials and inflation differentials in South Africa versus other countries,” he added.

A key factor driving rand strength is commodity prices, which are boosting South Africa’s terms of trade.

‘As long as the long end of our bond curve is relatively attractive, that will attract capital inflows, which could further strengthen the rand,’ King said.

Listen/read: What’s boosting the rand?

Overshoots 

‘The rand overshoots to the upside and downside. It can overshoot by 20% or so on the stronger end of the PPP level. So if you think the rand is fair around 13.50, then it could even go to the low 11s against the US dollar,’ he said.

During an interview after the webinar, he said that this was not Counterpoint’s base case view.

‘You shouldn’t be surprised if it overshoots by 20%. Historically, it has gone even wider than that. The reason it is even more likely than history is primarily that real interest rates are extremely high in South Africa,’ King said.

Consumer inflation 

‘In the United States, the ten-year government bond yield is below 2% while you are getting a 9.5% on a South African government bond yield for a similar rate of inflation. That kind of real interest-rate spread is a powerful carry trade attraction for global capital flows. It is very plausible that short-term capital flows will continue to strengthen the rand just on that basis,’ he said.

‘I see little standing in the way of [the rand going to 11 to the US dollar]. If there is a shock globally, that creates a kind of risk-off situation that could turn it around,’ King said.

The rand has strengthened by 20.6% to 13.81 over the past year, or an average appreciation of just over 1.7% per month. The last time that the rand was quoted close to 11 to the US dollar was in 2014.

Interest rates 

King believed that the spike in local inflation was probably transitory. Beyond the rise in food and petrol prices, the rand would likely keep a lid on imported inflation.

He said that he would be surprised if the South African Reserve Bank (Sarb) hikes interest rates as aggressively as the money market is pricing in, which is almost a percentage point over the next year.

‘Given the weakness of the underlying economy, they [the SARB] can afford to let inflation overshoot temporarily. If the rand overshoots and goes to the lower 11s, there will be no rush to do that [hike rates]. It will probably reflect a strengthening bond market because of improving government finances.’

Banks, retailers to benefit

He said that if the rand strengthened significantly, domestic companies with high leverage, like banks and retailers that sell goods on credit, would benefit. Investors holding local bonds would benefit from the decline in local yields.

‘The portfolios that are going to hurt are those that are overly exposed to offshore assets.’

This article was first published on Citywire South Africa here, and republished with permission.