Why the rand may just stay stronger for longer

Chris Freund, portfolio manager at Investec Asset Management, argues that if you strip away the noise surrounding the Rand, it is nothing more than a leveraged play on global risk. And with the risk trade back on as global growth recovers, the Rand is unlikely to depreciate substantially from current levels.

Although sceptics abound, we firmly believe that the green shoots of economic recovery have taken hold. By the end of the year, a globally synchronised economic upturn should be on track. Much of this recovery will simply be the normalisation from the extremes of last year, which saw the world economy going into cardiac arrest with inventory and output plummeting.

Cynics will argue that very weak employment data will hamper the recovery, but we anticipate a swing from a job loss situation to one which sees moderate job creation by early next year. Leading indicators in the US, such as the Institute for Supply Management's (ISM) manufacturing index, have already shown a firm uptick in the employment sub-component.

Adding impetus to the recovery will be the reluctance on the part of global policy makers to raise interest rates. At this stage of the economic cycle, they would normally be anticipating an economic recovery and begin to raise rates, particularly as interest rates globally are at abnormally low levels. But, having stared so deep into the abyss of economic meltdown, central bankers and governments around the world will be slow to take away the punchbowl. They would want to ensure that the economic recovery takes hold before raising interest rates.

Emerging markets will be the engines of this global growth. While they cannot ignore what is happening in their primary export markets of the US, UK and Europe, they are facing few of the impediments hampering growth in the developed world. They didn’t have over-leveraged consumers nor are they confronting massive budget deficits, so it is not unreasonable to assume that growth in emerging markets will far outstrip that of the developed world, which may well be sub trend for a long time to come.

So what does all this mean for the rand?

In our view, the rand is nothing more than a leveraged play on global risk. Don’t get too hung up on the noise surrounding the rand – the current account deficit, the budget deficit and the politics. Rather view the rand like you would an emerging market share.

So, assume that we can look forward to some continued good share price performance as stock markets around the world continue to discount the coming global economic upturn. As global risk appetite improves, emerging markets should perform even better, as they tend to go up even more when global equity markets rise. If this scenario does play out, which we believe it will – the rand, as the most liquid and sensitive of emerging market currencies, is unlikely to be left behind.

With central bankers reluctant to raise rates, the excess liquidity – combined with growing demand for resources as the economic recovery takes hold – could well result in commodity prices heating up again. As South Africa is one of the largest commodity producers in the world, this will provide further support for the rand.

And finally, the World Cup next year is likely to provide some capital flows and a welcome boost to confidence – all of which will be rand supportive.

We acknowledge that the rand is difficult to predict accurately, but if nothing else, keep it simple. If you expect shares to go up, you should be expecting the rand to strengthen. However, with plenty of resistance against a ‘too strong’ rand, we don’t anticipate it to appreciate substantially from these levels. But don’t just accept the prevailing wisdom that it is bound to weaken much either!