Bottom Line
• Since the previous report, the ZAR enjoyed a significant appreciative move followed by a major correction late last week that undid much of that. It moved from being overvalued back into undervalued territory, and the move was dramatic enough to raise some eyebrows. However, the charts which follow show that this move might not be sustained at the same pace, even though there has been part of a larger global move.
• Equity markets may be correcting, risk appetite has taken a beating, and higher beta emerging market currencies have all depreciated. US inflation spooked the markets and gave rise to another surge in bond yields. However, the ZAR Sentiment indicator (ZSI) remains in positive territory, carry attractiveness good, commodity terms of trade are still positive, and the prospects for SA’s economy are weak, which is good news for the trade account as imports are retrenched. While this is a tumultuous time and difficult to trade, it is also the best time to default to quantitative indicators that offer a clear and unemotional perspective.

Baseline View

It took just two days to wipe out most of the appreciation achieved in the month prior. It was a disappointing week and has investors concerned that this may be the start of a much larger correction. Although it will be difficult to escape a global crash in stock markets, should it materialise, the range of currently assessed indicators offers a more sanguine outlook and continues to favour some ZAR resilience. Exporters should stand ready to take advantage of these more attractive levels.

Broad expectations and understanding value ranges
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.

  • Once adjusted for risk, the ZAR is trading far closer to fair value which currently stands closer to 15.40. At this level, there is no obvious value for either side of the trade, although given the recent move to 16.00 from levels below 15.20 on Thursday, exporters are enjoying some reprieve.
  • The broader range of fair value remains between 15.20-15.60. Either side of that, marginal benefits might be extracted, depending on prevailing dynamics.

  • Earlier last week, implied ZSI levels have dipped sharply to highlight the underlying bias in the market that favoured ZAR appreciation. These implied levels should not be treated as specific levels to target, but rather as an indication of the balance of forces. When the implied rate hovers strongly below the spot rate, the guidance is that the ZAR stands a good chance of appreciating in the coming months. Friday’s move could see this reverse to some degree.

  • ETM’s ZAR Sentiment indicator (ZSI) has remained firmly in positive territory and even rose to suggest an appreciative bias will manifest over the next 6-8 months.
  • It suggests that any depreciation in the ZAR in the near-term will not be sustained in the future, especially if the ZAR finds itself in undervalued territory.
  • It is telling that the ZSI has remained in positive territory throughout the past month despite all the difficulties. It suggests that there is an underlying resilience to the ZAR which is bound to reflect in the months ahead.

  • With the rise in inflation, monetary rectitude has eroded despite the recent rate hikes. The accelerating growth in money supply suggests there is more monetary space for inflation to take hold and also implies that more rate hikes are needed.
  • Fiscal rectitude will to some degree be a function of what happens at a fundamental level. Fundamentals have also eroded slightly and that stands to reason given the prevailing headwinds, loadshedding and a difficult investment climate, all of which has weighed to some extent on the government’s fiscal position.

  • Although off its best levels, ZAR carry attractiveness has remained elevated and appears to have outstripped both the EM and DM averages. It implies that the ZAR still stands to attract foreign interest, which, at the margin, will assist in helping the ZAR retain some resilience.
  • It also implies that negative speculation against the ZAR will be more expensive, proportionately speaking, thereby dissuading such behaviour.

  • In the past month, the ZAR has staged a solid recovery and helped the real-effective exchange rate back to fair value before retreating on Friday. The significance of this is that there is no obvious valuation based opinion. Had it deviated significantly from the longer-term mean, that might be different. All that could be said at the moment is that the ZAR is trading at a very rare fair value level, not taking any fiscal or other country specific risk into consideration.

  • Although speculators continue to hold net long positions, the outsized move on the trade weighted USD index appears to be overdone. The size of the net long positions are not large enough to fully justify the kind of appreciation seen in the USD.
  • Add to that the slight reduction in the number of speculative long positions and a correction in the USD appears justified.

  • ETM’s inflation risk indicator remains buoyant, but does not point to inflation rising strongly above the upper limit of the inflation target band. This is a substantially more modest inflation picture than that of many countries abroad.
  • However, that might change once the government removes the fuel levy reprieve and fuel prices adjust aggressively later this year. Should they rise dramatically, the inflation data will experience a short-term spike.

  • Although the ZAR is not doing much to help contain the rise in inflation, it does not appear to be contributing massively in the way it has done in previous ZAR depreciation episodes. By comparison, the depreciation in the ZAR has been relatively modest.
  • It is also notable that the credit cycle remains tight and that it too will not contribute strongly to any sustained rise in inflationary pressures.

  • SA’s terms of trade have deteriorated markedly in recent weeks as the effects of much higher oil prices (SA’s biggest import) offset some of the benefits of the higher prices for SA’s exports. However, the terms of trade are still significantly higher than they were at the start of the pandemic, supporting the ZAR.
  • The initial bump up that occurred when the war broke out appears to have quickly dissipated as the focus shifts from anticipated scarcity to deficient demand.

  • Although the trade balance appears to be holding up reasonably well, a modest recovery in the SA economy has detracted from the surplus through stronger consumptive demand reflected in the credit cycle.
  • Whether that remains the case going forward remains to be seen. High inflation, rate hikes and other constraints may help to keep the credit cycle constrained, although there is some evidence of distressed borrowing.

  • While general government is reducing its fixed investment as reflected by the blue line, the private sector is picking up the shortfall. This would be in keeping with the general direction of reforms that the government is targeting.
  • However, it does reflect the structurally weak backdrop that constrains economic growth and which will detract from demand for imports. Only should these data ramp up, will the pressure on the ZAR intensify.