Broad Rates Expectations
The SARB has made it clear that it is committed to reining in inflation and inflation expectations after it delivered an outsized 75bps rate hike at its July 21 meeting. The MPC’s voting pattern was very interesting, with three members voting for a 75bp hike, one for a 50bp hike, and, surprisingly, one member voted for a 100bp move. The SARB noted that it would recalibrate policy based on incoming data as needed through the months ahead, but for now, there are few signs of inflationary pressures moderating anytime soon.
Interest rates expected to reach neutral level in 2023
The chart shows that while the SARB has front-loaded its hiking cycle, monetary conditions remain accommodative. SA’s real interest rate is still way below levels deemed neutral by the SARB. The current inflation rate puts the real interest rate, when calculated as the current policy rate less CPI, at -1.90%, which compares with a SARB neutral real rate estimation of 2.3-2.4% over the next few years.
This suggests that current rates are around 420bps below what the SARB would consider “growth neutral”. While this highlights the fact that monetary conditions are still accommodative, given that inflation is likely peaking, the implied level of accommodation is exaggerated. Taking into consideration ETM’s proprietary models, our base case is for the Repo Rate to top out at 7.00% in the current tightening cycle. That said, given how fluid the macroeconomic environment is at the moment, the risks of higher rates can’t be ruled out.
SA is not alone in its fight against inflation
As can be seen in the chart below, the number of central banks hiking rates by 50bps or more has reached unprecedented levels. There has been a notable shift in global monetary policy expectations in recent months, with policymakers around the world delivering significant rate hikes. Arguably, the most substantial shift has been from that of the Fed, which has embarked on an aggressive rate hiking cycle. This contrasts with indications just a few months ago that US monetary policy would remain accommodative. This shift has been consistent across the likes of the BoE, RBA, ECB and emerging market central banks, which have all taken steps to turn more restrictive as soaring commodity prices and ongoing supply chain disruptions continue to drive up inflation.
Broad FX Valuations:
It is often useful to find a tool that helps unpack value ranges quantitatively, preventing emotional decision-making when hedging. Traditionally, understanding value has been a somewhat nebulous concept that comes down to a range of factors, including what kind of tolerance a business has for unfavourable currency movements. The indicators that follow attempt to identify different periods that might offer relative value, either for importers or for exporters.
Even when adjusted for risk, the ZAR is undervalued against the USD. Although this undervaluation is not looking extremely stretched as yet, the ZAR is still a long way away from risk-adjusted fair value around R15.2000/$-R15.5000/$.
The further the USD-ZAR deviates from this range, the more uncomfortable traders are likely to become, suggesting this is an opportune moment for exporters to take advantage and lock in an attractive forward rate.
ZSI points to further ZAR Recovery:
The latest update of the ZSI model is pointing to a phase of recovery for the ZAR. The smoothed headline index has tracked the unsmoothed index deeper into positive territory, meaning traders in the derivatives markets view the asymmetry of the risk profile of establishing a long USD-ZAR position from current levels as high and rising.
Although the ZAR may still be subject to some turbulence in the months ahead, the ZSI suggests any bouts of depreciation will ultimately prove unsustainable with an appreciative bias set to manifest over the next six to eight months.
Although USD-ZAR levels as implied by the ZSI model have risen recently, as seen below left, they remain well below the current spot price to suggest the underlying bias in the market continues to favour ZAR appreciation.
Recall that these implied levels should not be treated as specific spot levels to target, but rather as an indication of the balance of risks facing the local ZAR. When the implied rate is notably below the spot rate, the guidance is that the ZAR stands a good chance of appreciating in the coming months.
ZAR Carry Appeal Remains Above the Emerging Market Average:
The ZAR remains amongst the most attractive currencies from a carry trade perspective, scoring well above both the EM and DM averages. This is largely a function of the ZAR’s undervaluation on a PPP-adjusted basis, SA’s large current account surplus, and the country’s relatively high real interest rates.
It implies that the ZAR still stands to attract foreign interest, which, at the margin, will assist in helping the ZAR retain some resilience.
As noted above, interest rates are still set to rise in the coming months as the SARB will look to rein in inflation and maintain its credibility.
In terms of valuation, the ZAR is only slightly undervalued on a nominal PPP-adjusted basis, although it is worth noting that this masks its near-15% undervaluation against the USD specifically. This dynamic reflects just how overvalued the USD is in general at current levels, with the ZAR ready to capitalise on any potential correction.
Given its relative undervaluation, the ZAR is also once again better positioned to respond to fundamental drivers, while its propensity to sell off further has also dissipated.