The rand, despite being unable to escape the developments made by the dollar recently, is fundamentally undervalued and should recover in coming quarters, says Michael Keenan, a forex strategy researcher from Absa.
Recent data from Absa’s Quarterly Perspective for Q4 found that the rand will recover despite both global and domestic risks alongside tightening monetary conditions having fattened the US currency.
The rand is trading at R18.37 to the dollar on Monday (31 October) after weakening over the past week as the dollar regained some lost ground ahead of the US Federal Reserve’s policy decision on interest rates.
“We find the rand weakness to be overdone and believe that it offers an attractive risk premium. We expect it to recover to R16.00/USD by the end of Q1 23,” said Keenan.
According to economists, the US Fed is likely to raise interest rates by three-quarters of a percentage point again. Economists expect Fed officials to maintain their hawkish stance, laying the groundwork for interest rates reaching around 5% by March 2023, potentially leading to a US and global recession.
Keenan said that in light of the global economy, the cost of dollars has made it tough for the rand to prosper, but Absa expects that it will see some improvement after an uncertain waiting period.
“We believe the rand has become fundamentally oversold. In recent months, the rand has weakened, most likely due to declining commodity prices and persistent capital outflows in the face of rising risk aversion.”.
The rand has also underperformed even when compared to other commodity-based currencies, he said.
He noted, however, that some of the rand’s weakness is due to domestic factors, with load shedding not boding well for growth prospects and concern still lingering around the potential greylisting and ANC elective conference at the end of the year.
“Our models suggest that the rand has weakened too much and currently offers an attractively high-risk premium,” Absa said.
For example, purchasing power parity suggests the exchange rate should be as low as R15.40/USD, given that South Africa’s inflation is well contained relative to US price dynamics, said Absa.
Hence, the bank believes the exchange rate could recover to R16.75/USD by year-end and bottom out at R16.00/USD by Q1 2023.
Keenan said in summary that the rand is undervalued in the short term, but the bank’s long-term projections from their fundamental models point to it being lower. He added that the million-dollar question for the rand is when international risk aversion will subside.-bustech
