Rand’s speedy recovery rally caught some traders by surprise

The rand’s rapid turnaround from April’s
record low has already burnt some traders’ fingers. There may be more victims,
judging by the discrepancy between forecasts for the currency and its actual

TD Securities’ long-dollar-rand trade,
opened on 21 May at 17.92 per dollar, was stopped out just eight days later
when the currency strengthened below 17.45, handing the position a 2.6{e93887a69cdd95d753f466db084bbc3aa0067124675315461d28d68a72842cc2} loss.
The trade was entered on expectations that easing by the South African Reserve
Bank would hurt the attractiveness of the currency – but the opposite happened.

The bearish predictions were not limited to
TD. Analysts in a Bloomberg survey see the rand reaching 18.95 per dollar in
the second quarter – implying a decline of around 8{e93887a69cdd95d753f466db084bbc3aa0067124675315461d28d68a72842cc2} from Friday’s level of
17.50 per dollar. The probability of the rand weakening that much by the end of
June is less than 10{e93887a69cdd95d753f466db084bbc3aa0067124675315461d28d68a72842cc2}, according to Bloomberg’s forecast model based on prices
of options to buy and sell the currency.

In the context of rising US-China tensions
over security legislation in Hong Kong, along with a deteriorating economic
picture in South Africa, the timing of the rand’s rebound “has been a bit
surprising,” said Per Hammarlund, chief emerging markets strategist at SEB
AB in Stockholm. Still, “given that the rand and most other
emerging-market currencies have some way to go before being back at levels from
before the Covid-19 outbreak, the rally has enough legs to last through the end
of the second quarter,” he said.

The rand has strengthened 5.6{e93887a69cdd95d753f466db084bbc3aa0067124675315461d28d68a72842cc2} in May, it’s
first monthly advance this year and the best since January 2019. On the way, it
breached two key resistance levels to further gains: the 50-day moving average
at around 18.20 and the 23.6{e93887a69cdd95d753f466db084bbc3aa0067124675315461d28d68a72842cc2} Fibonacci retracement from April’s record low, at
18.04. Next up is the 38.2 retracement at 17.24, and a sustained breach could
see the currency heading toward 16.50 per dollar, according to Credit Suisse SA
and Standard Bank Group.

While a tentative return of risk appetite
worldwide contributed to the rand’s advance, the currency also received some
support from a relatively hawkish central bank. The regulator on 21 May curbed
expectations for further aggressive easing after cutting its benchmark interest
rate for the fourth time in as many months in a bid to support an economy
forecast to slump deeper into recession.

Also bolstering the currency were signs
that record outflows from South Africa’s domestic bond market may be coming to
an end. Foreign investors started trickling back into local debt in the second
half of May, after selling a net R66 billion this year.

After returning 6.2{e93887a69cdd95d753f466db084bbc3aa0067124675315461d28d68a72842cc2} in May for investors
who borrow dollars to buy high-yielding currencies, known as the carry trade,
the rand’s one month volatility-adjusted implied yield has climbed to the
highest in nearly two months. That suggests more rewards may be in store for
investors willing to risk buying one of the emerging world’s most volatile

Still, there are risks ahead. Rising
tensions between the US and China could spill over into emerging-markets, while
South Africa’s economy has yet to show the full hit of the coronavirus

“The question on most people’s minds
at the moment, is what to make of this recovery in the rand and can it be
sustained to much stronger levels?” asked Warrick Butler, a
Johannesburg-based trader at Standard Bank. “The answer to this is not
that straightforward,” though short-term gains are likely to continue, he

Still, “there is only so far it can
go,” Butler said. “The more the elastic band stretches, the more pain
will be felt upon its release.”

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