Rand bounces back

The following is a post by Marc Chandler, head of Brown Brother Harriman’s Currency Strategy Team. For more of BBH’s currency views, visit the website here.

The South African rand is benefitting from two forces.  The first is the generalized recovery in risk appetites, illustrated by rising equity and commodity prices.  The second force is special to South Africa.  After a slow start the rand rallied in the European morning, even as the euro slipped to session lows.  The proximate cause of the rand’s out performance was comments by Finance Minister Gordhan.  He retained the tight budget introduced last Oct that seeks to reduce the deficit by a 1.1 percentage points to 6.2% of GDP in the year through March 2011.  Gordhan also is emphasizing efforts to keep inflation in check, even though the nearly 1 in 4 are unemployed (24.3% in Q4 09).

Although there was some political pressure to widen the 3-6% inflation target, Gordhan successfully resisted it.  Nor did he seem sympathetic to increasing the central bank’s mandate to include growth and or unemployment considerations.   Lastly, Gordhan sent a shot across the bow of the civil servants, who will likely see salaries capped and while taxes in general increase.   In fairness, there was one new program proposed today and that was a subsidy for low skilled wages for new workers.

South Africa has a modest debt to GDP ratio of about 23% of GDP as of March 20090.  There had been some thought, given the platform of the ANC that President Zuma would have been more liberal with his spending.

Before Gordhan’s speech the dollar was just below ZAR6.68 and quickly dropped to almost ZAR7.58. This is the strongest the rand has been since Feb 4.  This left the greenback a bit oversold. ZAR7.62 should cap upticks and a close below ZAR7.60 would suggest additional near term dollar weakness.  The ZAR7.50 area is the next main target.   Behind the firmer ZAR tone could be flows into the bond market.  The 9% yield on the 10-year benchmark looks relatively attractive and the recovery in commodity prices may help buoy the equity market.

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