South African Rand Gets Cornered in a One-Way Bet as Rate Hike Seen Unlikely

JOHANNESBURG (Capital Markets in Africa) – One of the biggest differences between central banks in South Africa and Turkey is credibility, according to S&P Global Ratings. But as the rand tumbles to a two-year low amid a broad emerging-market sell-off, that strength is becoming a problem for the currency.

The South African Reserve Bank’s policy of targeting inflation and leaving the rand to the markets is making it something of a one-way bet at a time when other central banks are supporting their currencies. And with South Africa’s economy in recession, the probability of policy-tightening is fading.

“Markets are likely to test the South African Reserve Bank, which is generally reluctant to hike rates in defense of the rand,” Win Thin, the New York-based head of emerging-market strategy at Brown Brothers Harriman & Co., said in a client note on Sept. 3.

The South African central bank’s mandate is to keep inflation in a range of 3 percent to 6 percent. With the consumer price index firmly within those limits, the bank is unlikely to raise rates unless it sees evidence of rand-fueled price increases. It hasn’t intervened in the market to support the rand for two decades. “You can’t respond to noise,” SARB Governor Lesetja Kganyago said in an interview with Bloomberg last month.

Money-market rates underscore the central bank’s credibility. Even after the rand’s slump this week, forward-rate agreements are pricing in less than a 60 percent chance of a 25 basis-point rate increase at the next Monetary Policy Committee meeting on September 20. That means traders don’t have to look over their shoulders to the central bank while shorting the rand over the coming weeks.

That’s partly why the rapidity of the rand’s decline this week caught many traders off guard. The currency extended its slump on Wednesday, outpacing even Turkey’s lira and Argentina’s peso as it posted a three-day drop of almost 6 percent against the dollar. The rand weakened 1.7 percent on Tuesday to 15.6132 per dollar, heading for the lowest close since June 2016.

“I am the biggest bear on the rand and emerging-market FX, but I am really surprised by this move,” said Mehul Daya, a strategist at Nedbank Group Ltd. in Johannesburg who has been warning since early this year that the rand would be under pressure as global dollar liquidity dried up.

Source: Bloomberg Business News