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Views Article – Sharenet Wealth

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Where Is Rand Support Coming From?

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Over the past month, foreign inflows still managed to find their way into South Africa despite the current uncertain political and economic environment. These inflows are one of the main reasons that the Rand could show some resistance to recent political events and sovereign downgrades.

The important question is, what do these foreign countries know that still encourages them to invest in South Africa? The answer becomes quite clear when we compare the real Fed funds rate and the real SA Prime rate. From the carry spread in Figure 1, it can be seen that South Africa is still an attractive investment as the spread opens up for the end of March.

Figure 1: Real SA prime rate vs real Fed Funds rate

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Sources: FRED Economic Data & SARB

With US real rates remaining in negative territory since October 2015 and showing a rapid decline in recent times, US investments are experiencing lower after-inflation returns. In South Africa, the possibility of rate cuts in the near future has decreased due to recent events. The outlook for inflation remains positive with a stronger Rand since 2016, declining oil prices, and an expectation that food prices will also decline. As a result, the strategy is as simple as borrowing at negative real rates and pocketing positive yields in SA.

There are many factors that influence USDZAR movements, and the carry trade is definitely one of them. In Figure 2 it can be seen that when the carry moves above 6%, the Rand strengthens, and that is the state we are currently moving in. This knowledge on where you think the Rand is headed can be used to make a Long/Short pairs trade on the JSE, using the dynamic table and trading strategies provided in the article TOP40 Offshore Revealed.

The carry trade supporting the Rand will remain intact as long as US inflation increases faster than the Fed rate and SA inflation keeps making its way closer to its target range. This provides the SARB with some flexibility in not being forced to follow the FED into its hiking cycle. 

Figure 2: Exchange rate vs carry spread

image2

From these comparisons, it can be concluded that the stronger Rand is not due to an idealistic perception of our economy that only foreign countries can see, but purely the attractiveness of the SA-US carry trade.


joani

Joani van Wyk
Analyst

Joani van Wyk joined the asset management team in January 2017, responsible for quantitative research of equities across all industries. Joani completed her degree in Mathematical Science in 2015, as well as an Honours degree in Financial Risk Management in 2016, both at the University of Stellenbosch.


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