27 July 2023
“Alarms over stage 10 load shedding leave the Rand reeling.”
“South African Rand drops to 3-year low on loadshedding fears.”
“Rand crumbles as load-shedding pressures mount.”
These are just a few headlines from local and global news outlets over the past six months linking movements in our currency to South Africa’s on-going energy crisis.
As the currency slides to the sound of your UPS kicking in, it is easy to attribute these moves to purely local factors, but the data suggests that movements in the Rand exchange rate are dominated by global rather than local factors, and despite making fewer local headlines, J. Powell has likely had more impact on the Rand than J. Zuma.
To test this, we compare movements in the USDZAR exchange rate to a basket of global emerging market currencies. If a Rand move correlates with these other Emerging Market currencies, then that move is likely explained by global rather than local factors.
A regression of the USDZAR level on the JP Morgan Emerging Market FX Index has an R2 of almost 80%, suggesting that four-fifths of Rand variability can be explained by global factors that are common to all Emerging Market currencies.
This simple model allows us to estimate what part of the Rand’s swings are due to global factors and what part is due to local factors. In addition, the persistence of load shedding now means that we have a long enough data series to quantify a local risk factor in the form of the average load shedding level per day.
Modeling the USDZAR as a function of these two factors gives the result below.
Source: Bloomberg, ESP, Mergence
Here the yellow line is the component of the USDZAR that can be explained by global factors, the orange area is the impact of load shedding, and the grey, is the residual that must be explained by other SA-specific risks. As a check of this model, we have highlighted periods of large positive and negative SA-specific risks that seem to correlate well with material news events at the time.
Based on this model, SA-specific risk priced into the USDAR has declined over the past month, with a current decomposition of
Comparing this to the end of May shows how load shedding risk has reduced and other SA-specific risk has now swung negative. The ZAR is now outperforming its Emerging Market counterparts, given our current level of load shedding.
With recent SA-specific risk no longer reflected in the currency, the scope for further Rand strength will rely on global factors, a weaker dollar, and a strong economic recovery from China. The peak of the US interest rate cycle and increasing Chinese stimulus should lend Emerging Market currencies support against the Dollar, but a global recession later this year or next year could be a material headwind.
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