Summary of Key Points:

  • As bad as the ZAR’s performance was in May, it was impressive throughout June, although towards the end of the month, its performance vs the majors fell away again. The performance appears to have coincided with the resurgence in the domestic bond market, suggesting that some of the demand for SA bonds came from abroad. The greater the degree of attraction for SA bonds, the higher the probability that the ZAR will stage a recovery.
  • Central to the direction of the FX markets is monetary policy that continues to dictate the direction of flows. Not only are investors considering the spread between different interest rates, but the cost of speculating against a currency and the level of risk appetite. All three are directly affected by central bank policymaking. Where we find ourselves in the interest rate cycle matters. So, while the Fed remains hawkish and points to further rate hikes, the USD will remain well supported. However, that cycle will change later this year, and given how much has been priced into the USD, it may find itself a little vulnerable and more susceptible to depreciation.

Baseline View:

The ZAR remains extremely undervalued despite recovering somewhat through June. SA faces many challenges, and those have elevated SA’s risk profile. Some of the ZAR’s undervaluation is therefore justified. However, even if one adjusts for that risk, the ZAR remains heavily undervalued, implying that there is room for the ZAR to recover later this year, especially if the interest rate cycle in the US turns.