What lies behind the recent Rand strength

Figure 1: USDZAR

The COVID19 pandemic, coupled with a build-up in economic vulnerabilities prior to Covid19 meant that sentiment around South Africa (SA) was particularly fragile. These vulnerabilities included a weakening fiscal outlook, liquidity problems at numerous State-Owned Companies (and associated bailouts) and ongoing electricity shortages; all of which contributed to a ratings downgrade to junk status by Moody’s. The severity of the pandemic- the high contagion rate, soaring mortality rates and a slow and uncertain response from the government, all acted to further erode investor sentiment, thereby weakening the rand and increasing market volatility. During this time, we saw the USDZAR trading at over R19/$. In recent weeks, however, the rand has gained substantial strength, and is now trading below R14/$[1] (see Figure 1). We explore some of the reasons for the rands remarkable recovery below.

Dollar weakness

Global markets are weighing the combined impact of fiscal and monetary policy in the United States (US). The large-scale fiscal stimulus in the US on the back of COVID19 may fuel rising US inflation. This may lead the Fed to hike interest rates in response to the demand-pull pressure in the US economy [2]. In this scenario, real US interest rates would rise faster than expected, dampening global demand and redirecting investment funds back to the US. This would force SA asset prices to adjust i.e., the rand would weaken, and interest rates would likely rise.

Global markets are weighing the combined impact of fiscal and monetary policy in the United States (US). The large-scale fiscal stimulus in the US on the back of COVID19 may fuel rising US inflation. This may lead the Fed to hike interest rates in response to the demand-pull pressure in the US economy . In this scenario, real US interest rates would rise faster than expected, dampening global demand and redirecting investment funds back to the US. This would force SA asset prices to adjust i.e., the rand would weaken, and interest rates would likely rise.

However, over the past few weeks, the Federal Reserve Governors have eased market concerns, causing emerging market assets, specifically those in SA, to rally, and the dollar to weaken. The Atlanta and St. Louis Fed Governors Lael Brainard and James Bullard indicated that US interest rates won’t be hiked any time soon [3]. They did, however, add that there could be price increases on the back bottlenecks in the US economy, linked to supply shortages, but they believed these to be temporary and did not warrant Fed hikes.

Chase for yield

From an economic perspective, interest rates, inflation and exchange rates go hand in hand. If one compares SAs 10-year bond yield relative to that of the US, post the Moody’s ratings downgrade last year, the SA-US interest rate differential was the highest in about 20 years. However, although this gap closed relatively 

quickly, the relatively high real interest rates offered in South Africa continue to attract offshore investments and capital[4]. This provides support for the rand. Current account surplus supported by commodities

A country’s current account reflects all payments between countries for goods, services, capital flows, interest and dividends [5]. SAs current account recorded a surplus of 3.7% of GDP in Q4:2020, following an even larger surplus of 5.9% of GDP in Q3:2020 [6]. Q3:2020’s surplus was the largest recorded surpluses in SAs history [7], and was preceded by a deficit of 2.9% in Q2:2020. This swing can partly be attributed to the strong global commodity boom in recent months. A strong commodity run has historically been rand positive, and for as long as this upswing continues, it will provide significant support for the rand.

Growth concerns ease but fiscal concerns remain

The recent gains in the rand also came off the back of strong income-tax data published by SARS last week. This was largely due to higher profits from mining companies on the back of rallying commodity prices. Furthermore, the three major ratings agencies (Fitch, S&P Global Ratings and Moody’s) held SAs credit ratings constant. Ratings downgrades would have meant that SA assets would move deeper into junk status. Some of the reasons highlighted by the respective ratings agencies was that SA’s growth concerns have “improved substantially”, despite continued “substantial risks to debt stabilisation”[8].

What is in store for the rand?

Global risks such as rising US inflation remain at bay for now. As such, the rand may continue to benefit from risk-on sentiment. However, local risks remain. While SA’s economic growth is still a source of concern for investors, an upswing in the commodities cycle could provide support to the current account and the rand. However, SA still faces serious fiscal challenges, including large government debt and tricky negotiations around the public sector wage bill. Adding to this, the slow start to the COVID19 vaccination programme and the threat of a third Covid-19 wave could add downward pressure to overall investor sentiment. These real economy risks are likely to limit future rand strength.


[1] Standard Bank published exchange rates

[2] (Parkin Powell Matthews, 2008)

[3] Bloomberg

[4] (Parkin Powell Matthews, 2008)

[5](Parkin Powell Matthews, 2008)

[6]South African Reserve Bank

[7]South African Reserve Bank

[8]S&P Global Ratings, Moody’s Ratings agency and Fitch Ratings agency.