2018 End of Year Rand Forecast

We often get asked by clients to peer into our crystal ball and provide a forecast for the South African Rand. This, I’m afraid is a very difficult undertaking, especially when you consider South Africa’s unique economic and political situation.

Forecasting the Rand is very challenging in the short-run. There are far too many independent variables to consider, which pundits omit and end up basing their decision on historical patterns that confirms pre-existing beliefs. Behavioural economists refer to this process as hindsight and cognitive bias. Much of the Rand’s price direction comes from the USA, Asia & Europe, with around 70% of daily transactions taking place outside of South Africa’s borders. Trying to account for all the possible permutations is incredibly difficult unless you take a longer-term view.

We don’t enjoy forecasting the Rand. Why? Even after thousands of hours spent researching and analysing fundamentals, there are still factors that are completely unpredictable, think #nenegate. We do however believe that there are notable macroeconomic events and economic formulae that may be used to derive value and we hope to apply these below.

 

Economic Models – PPP & IRP

We have decided to use two popular measures to assist us with a forecast. The Purchase Power Parity (PPP) and Interest Rate Parity (IRP) are economic models that are often used when looking to determine future currency performance in the medium to long-term. They take into account the differences in inflation & interest rates between the currency pairs and their respective countries. Generally, the country with the higher inflation/interest rate should expect its currency to weaken. In our case, South Africa has both higher inflation & interest rates when compared to the USA and therefore the Rand is expected to gradually depreciate over time as it has over the past 24 years.

Although these formulae are fundamentally sound, we know too well that economic theory and real-world application are two different things. They seem to provide us with a decent outlook as to where the rand should be trading, roughly. For more info on these formulae see the Investopedia link here and here.

Graph explained:

The valuation band for the two models forecasts the price of the Rand somewhere between 14.28 & 15.61. We then took an average of the two forecasts and smoothed it with historical prices. This gave us a combined price of USDZAR 14.51, forecasted for the end of 2018. This target is currently 97c above the USDZAR 13.54 rate at the time of writing. We attribute the much of 97c buffer to risk premium. If you would like to see further information on our calculations process, please don’t hesitate to contact us.

Technical Analysis as a forecaster of exchange rates.

Technical analysis provides a large basket of tools and strategies for trading currencies. There are successful traders that don’t use it, and there are successful traders that do. Ultimately, it is up to each individual to explore technical analysis further and determine if it is right for them. It doesn’t guarantee a return or provide 100% accuracy, but for those who diligently practice the concepts, it does provide a realistic possibility of success.

Below we have provided a link to commonly used moving average indicators. These are used in technical analysis to provide an indication of the relative value of the Rand based on historical inputs. The below measures were captured in July 2018.

For a live view of these technical indicators, see here.

We like to compare our forecast alongside those of prominent Rand forecasters. At the date of writing. The below entities had presented the following forecasts – with links.

2018 End of Year USDZAR Forecast

Trading Economics – 14.72
Long Forecasts –  15.17
ING Group – 14.50
Commerzbank – 14.80
JP Morgan  – 14.40
Morgan Stanley – 14.50
Bank of America Merrill Lynch – 15.00

Average: USDZAR 14.72

If you would like to have your forecast added to the above list, please feel free to pop us an email and we’ll be sure to add your forecast and link.

In conclusion.

We have to forecast. If we didn’t, our voice would not be heard and we would not be able to express our viewpoint on forecasting. After assessing our analysis, technical factors & the “experts”, one can see that the Rand is expected to weaken in the coming year. This is partly a result of natural currency depreciation thanks to our inflation & interest rate situation.

That being said, we also must look at the “risk premium” that is added to the Rand as an emerging market country. This premium is a result of all the economic, social & political concerns South Africa holds. Notice how the premium shrunk as soon as Cyril Ramaphosa was elected President. For a brief moment the Rand suffered from less uncertainty and thus the premium was reduced. Fast forward to today and the situation is quite different. Government Debt continues to rise as a result of wasteful expenditure and poorly run SOE’s. The premium has been priced in again and the Rand may be in for a wild ride.

Our best advice for people looking to minimise their Rand exposure is to speak to professionals who have knowledge of hedging options available to South African Individuals & companies. Hedging removes the uncertainty when exposed to foreign currencies and is easier to set up than you may think.

We are happy to report that our forecast of USD/ZAR 14.51 falls in line with those of ING, JP Morgan & Morgan Stanley. We will continue to add other notable metrics to this report as the year develops.