The rand has depreciated in an almost straight line for the last three years, losing more than 70% when it reached its weakest level around 11.40 to the US dollar in January. The recent recovery of the rand has been most welcome as it moderated many over-pessimistic projections of the rand. This should however be seen as a retracement of a strong trend, so further weakness in the rand should be expected.
This is the view of George Herman, head of South African investments at Citadel, who says that because of the severe pressure on global emerging markets in the last three years, including South Africa, the rand's volatility is expected to continue, presenting select opportunities for investors.
"As quantitative easing is tapered in the United States, yield searching carry trades are being unwound, causing much uncertainty and volatility in emerging country currencies. The rand has therefore not escaped developed market investor scorn. It remains a prime target for further sell-offs as global rebalancing takes place. Only once the entire emerging market complex returns to healthy growth, while avoiding any new systemic calamities, will the rand enter an environment in which it can appreciate meaningfully. Until then, look for weaker rand levels and buy dollars in the dips," explains Herman.
Furthermore Herman says that many emerging market economies are facing elections within the next months, and that there may be unintended consequences for currencies. "Many emerging markets, including South Africa, face an election during the next few months. Elections don't pose an enormous risk, but unexpected changes to economic policy or social unrest and violence do."
Herman explains any improvement in the rand should only be expected once a variety of economic factors in the country have been addressed.
"The rand is currently undervalued and that it should appreciate over time and periods of over-or under-valuation can continue for several years. The rand is on a downward trend and may only reach its bottom once the emerging market carry exodus is complete. By then the endogenous factors underlying the rand's vulnerability, namely, the large current account deficit, labour unrest, electricity shortages and political uncertainty, should have improved or stabilised. Only then is it likely that the rand may start reversing its undervalued status."
According to Big Mac purchasing power parity (PPP) model, which compares relative valuations of currencies according to the cost of a McDonalds Big Mac burger, the rand is the most undervalued currency in the world at 59%. "One should therefore never see the rand as a one-way bet and that it will weaken forever, as it may improve with time," warns Herman.
Herman says that, however, current market concerns may have a further negative effect on the rand and other emerging market currencies.
"China's slow growth is placing pressure on emerging currencies as the market considers these economies to be at risk in such a slow-growth scenario. In addition, as the US Federal Reserve (the Fed) purchases fewer fixed income instruments from the market, it decreases the supply of low-rate funding to US banks to invest in high yield territories. Current expectations are that the Fed may reduce asset purchases at a constant rate. If they increased the pace of tapering for any reason, emerging market currencies would experience severe sell-offs."
