BHEKI MAHLOBO: Strong rand outlook if election delivers unity government

Despite the political uncertainty surrounding the May 29 election, the rand may be positioned for appreciation through the third and fourth quarters of the year should the Federal Reserve begin cutting interest rates.

The trend in the US is of a weakening economy intersecting with an inflation rate approaching 2%. Rate cuts would see the dollar lose strength as investors seek higher returns in riskier asset classes. If the May 29 vote brings about a workable coalition arrangement in SA, or even a government of national unity, the country’s competitive interest rate differential would be an attractive proposition.

Given the historical inverse relationship between dollar strength and commodity prices, a weaker greenback would also support SA’s trade balance, and thereby the currency. 

There was a small uptick in the US unemployment rate to 3.9% in February, from 3.7% in January, marking the third monthly lift for that indicator in the past 12 months. The rise occurred amid revisions to payroll numbers that saw the January figure for new jobs added to the economy revised downwards by 124,000 to 229,000, and the December figure revised downwards by 43,000 to 290,000.  

Despite the upticks and revisions, the numbers are still extremely strong. However, when read against the Institute of Supply Management non-manufacturing purchasing managers’ index (PMI) number, they sound a cautionary note about what may lie ahead for the US economy. That number declined from a record high of 67.6 points in November 2021 to 52.6 points in February 2024.

While still in expansionary territory, the slippage heralds slowing US growth in the services sector, which accounts for about 60% of its GDP. Add to that the manufacturing PMI number, which last breached the expansionary 50-point mark in October 2022 and dipped again in February 2024, and the cautionary note rings still louder.

Despite those numbers, Fed credibility demands that the institution make no firm moves until inflation is on the brink of the targeted 2% level, and this is still some weeks off. The US inflation number printed at 3.2% at the end of February, down from a peak of 9.1% in June of 2022. The figure fell sharply from that high to bottom out at 3% in June 2023, and has since remained sticky near that level.

This is despite both food and fuel inflation moderating (food to a low of 2.2% in February, a two-and-a-half-year low, and fuel to negative levels). Inflation in housing and rental prices has remained sticky though, but that may change given house sales data suggesting that demand for homes has started slipping, with the implication that prices may come down.  

Globally, food prices as measured by the World Bank’s food price index have fallen to a three-year low. Energy prices have also dropped, with Brent crude oil hovering around $82 a barrel, down from an eight-year high of $119.02 in June 2022. Should global shipping be largely insulated from the wars in Europe and the Middle East, broader US economic input costs may continue to ease.

However, that won’t happen in the very short term, with the Baltic Dry index, which tracks the prices of shipping bulk commodities around the world, having risen exactly 80% so far in 2024 while container prices have lifted by over 220%. The flag to watch here is Yemen and whether Iran will pressure its Houthi proxy into limiting attacks on Red Sea shipping.  

The prospect of lower rates in the US has already induced some dollar weakening, given signals from the Fed, most recently in the appearance of chair Jerome Powell before the Senate last week, that the Fed would begin considering rate cuts towards the end of 2024. The dollar index is well off its post-Covid October 2022 high of 113.07 and had come down to 103.89 before Powell’s Senate remarks, falling to 102.83 shortly thereafter.  

From an SA perspective, dollar weakness is rand positive for more reasons than the direct tie between the index and the local currency. There is also a historical inverse relationship between dollar strength and commodity prices. A weaker dollar generally leads to stronger commodity prices, which is positive for SA’s trade balance and by extension the local currency. 

Turn now to the outlook for Europe and the UK, where weak growth means central banks will follow the Fed lead as soon as US rate cuts are announced. The eurozone stagnated to record zero growth in the second half of 2023, while its composite PMI (services and manufacturing performance) number remains in contractionary territory, where it has been for the past nine months. The UK has already slipped into recession.   

From a commodity perspective, the China outlook is positive given that rates have already been cut while liquidity injections may stimulate local demand. The composite leading indicator for China, drawn from Organisation for Economic Co-operation & Development data, has since April 2023 remained above the important 100-point mark, which suggests expansionary, and therefore improving, economic conditions.    

Attractive proposition

Into the end of the year SA may therefore find itself confronting a fortuitous set of external circumstances. US and European interest rates could well be falling as commodity prices rise should Chinese demand surprise on the upside. A search for higher yields would make the local currency an attractive proposition, given the likelihood of a wide or even widening interest rate differential should the SA Reserve Bank cut rates at a slower rate than its global peers. As a consequence, external factors may see the currency strengthen to levels even below R17/$.  

That prospect will ultimately hinge on the outcome of the May election and the nature of the government that is formed in its aftermath. The latest poll numbers released by The Brenthurst Foundation show that support for the ANC has slipped to below 40% nationally, and that the party is set for landslide defeats in Gauteng and KwaZulu-Natal.

Should the consequence be an ANC-EFF coalition, populist changes to SA’s fiscal and monetary policies may follow and as a worst case result in the rand replicating what occurred to the peso in Argentina in August 2019 and to the naira in Nigeria since May 2023.

However, we believe a more likely outcome is for President Cyril Ramaphosa to call a government of national unity after the vote, and while this possibility will need to be reassessed regularly ahead of May 29, such an outcome will be interpreted in an extremely positive light by the markets.  

• Mahlobo is a partner at advisory firm Frans Cronje Private Clients.