ZAR levels are still very favourable for exporters in USD and EUR            

Bottom Line

  • On a trade-weighted basis, the ZAR has lost ground. The bulk of the underperformance came against the EUR, one of the best-performing majors over the past four months. The ZAR’s overall undervaluation now stands at approximately 6-7%, which, although not extreme, leaves room for the ZAR to stage a trade-weighted recovery.
  • Against the USD, the ZAR remains significantly undervalued but has started its recovery, mostly on the back of the USD losing ground. Against the EUR, the ZAR is at its most undervalued, but that means there is more scope for recovery than further depreciation. The asymmetric risk, therefore, lies in the ZAR regaining lost ground.


Baseline view:

Exporters will find value in repatriating funds out of USDs and EURs, although less so against the GBP trading close to fair value. The potential for ZAR strength also implies a more favourable inflation outlook, which alludes to greater ZAR resilience. The outlook for the year ahead is a very constructive one for the ZAR.

SA’s trade balance remains a cornerstone to ZAR resilience

A sharp drop in oil prices and the price of some of SA’s export commodities holding up has resulted in SA’s terms of trade recovering. This is excellent news for the ZAR as it will actively boost SA’s trade and current account data and lend substance to the ZAR’s performance.

Over and above these favourable terms of trade, SA is also about to experience a difficult phase of weak economic growth. This should not be underestimated, as historical studies have shown that the ZAR tends to perform better in a weak growth environment. The weaker the aggregate demand, the weaker the demand for imports. If this happens to take place at a time when terms of trade are buoyant, the fundamental support for the ZAR is given a further boost.

H1 2023 appears to be a phase characterised by weaker economic growth where demand for imports will also be curtailed. This supports the argument that the ZAR could enjoy a phase of appreciation throughout most of the year, especially through H1 2023.

USD overvaluation has retreated off its highs but remains extreme

lot has been made of the USD’s retreat in recent months. The recent CFTC data shows that speculative positions on the ZAR have turned bearish, albeit marginally, and strategists are increasingly predicting a much weaker USD for 2023.

However, pulling back the lens on the USD’s performance shows that it remains extremely expensive and overbought. The accompanying chart shows that the USD may have retreated off its recent highs, but it remains in the rarefied territory and is ripe for a cyclical retreat.

Furthermore, the USD could retreat 10% from current levels and still remain in overbought territory. This offers some context as to how the USD could lose ground and still satisfy the belief that it deserves to trade at stronger levels vs many of the majors on account of the US’s superior growth dynamics and the more attractive interest rates on offer.

The point is that the USD remains too expensive, and if history is anything to go by, such levels have proved impossible to sustain. The USD has begun its correction and has a way to go before it mean-reverts and re-establishes its long-term cyclicality. Counting against the USD are the US twin deficits, the rapidly declining inflation and expectations that the Fed will pivot towards easier monetary policy.

ZAR Performance is better than its performance vs the USD suggests

Since the previous report in Oct last year, the ZAR depreciated further on a real-effective trade-weighted basis to record an undervaluation of 7%. Since then, the undervaluation has moderated slightly to around 5%.

By no means can such an undervaluation be described as extreme. However, it does highlight that there is room for the ZAR to appreciate and still not be regarded as expensive. Recall that this is against a basket of currencies and reflects the overall trade-weighted valuation. The bulk of the ZAR’s undervaluation is against the EUR and the USD, not the other majors.

So the ZAR might recover against the USD and EUR but stay flat or even depreciate against the GBP or the JPY. Given the strength of commodity prices and the favourable terms of trade, this looks plausible. Add to that ETM’s guidance from the ZAR Sentiment Indicator and carry attractiveness, and a phase of ZAR appreciation looks likely.

Output of updated valuation calculations:

  • The extreme undervaluation of the ZAR vs the USD towards the latter weeks of 2022, was not sustained. Off its most undervalued levels of 20%, the trade weighted ZAR has unwound at least 7% of that.
  • Current undervaluation, therefore, stands at approximately 13%, which highlights the potential for the ZAR to still make back at least 10% against the USD.
  • In nominal terms and using a base of 16.90/dlr, the ZAR could regain at least R1.69 vs the USD. That would place the pair closer to 15.00/dlr and if one accepts that it could even rotate into overvalued territory against the USD, then levels back below 15.00/dlr are possible.

  • Against the GBP, the ZAR is trading close to fair value. Within a 5% range either way, this implies that the ZAR has been fairly stable against the GBP for most of the past two years, save for a few temporary breaches of the range.
  • Much of the ZAR’s overvaluation against the GBP has dissipated and that was largely a function of the post-Truss recovery. Off the lows reached in Sep, the GBP has rallied almost 20% against the USD.
  • It is therefore quite impressive that the ZAR lost only 5% to the GBP to head back to fair value territory.
  • There is no obvious direction that can be deduced from this study.

  • Of all the currency pairs, the ZAR’s worst performance has come against the EUR where the ZAR has lost between 10-15% since the previous report in Oct.
  • The ZAR now stands in deeply undervalued territory against the EUR at an unsustainable level of 20%.
  • There is now obvious value for the ZAR to make a recovery against the EUR, and the catalyst for that might be the turn in the inflation and interest rate cycle.

  • Not much has changed concerning the ZAR’s performance vs the CHF as it remains close to 5% overvalued.
  • Interventions by the SNB have kept the CHF artificially weak, although with so much global uncertainty doing the rounds, the CHF has the potential to regain its safe-haven status, albeit at the margin.
  • Nonetheless, against the EUR, the CHF has been under greater pressure which means that the ZAR has held its own,

  • Japan’s BoJ has tweaked its monetary policy by allowing yields on the 10yr bond to fluctuate 50bp either side of its 0% target.
  • While the move was intended to improve market functioning, it was interpreted as hawkish as the central bank would tolerate yields rising.
  • Carry trades were unwound and the JPY recovered lost ground. Although the ZAR remains overvalued vs the JPY, that degree of overvaluation has moderated significantly by 15% since the last report

  • As the PBoC chose to run with looser monetary policy, it constrained the performance of the CNY. The ZAR is trading at fair value which has held for most of the past year.
  • The central bank will not want to tighten policy while the country still faces major growth headwinds and while the property sector still needs support.
  • Looking ahead, the PBoC will ensure that the CNY is managed as it has been implying that the ZAR will likely continue to consolidate its current valuation.