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Managing foreign exchange volatility

Jun 11 2018 13:55
Carin Smith

About one hundred days into Cyril Ramaphosa’s presidency, Alison Barker, owner of FX Solutions Wealth, a ForexPeople franchise, provides Fin24 with a health check on the rand and tips for managing foreign exchange volatility.

Please give us a snapshot of the current state of the rand.

The rand was under pressure for most of 2017, reflecting local politics and the outcome of the ANC elective conference; the threat of additional credit rating downgrades; and rising interest rates in the US impacting all emerging markets thanks to less money flowing our way.

But the ascension of Cyril Ramaphosa was the catalyst to a rand rally on expectations that the new president would focus on the economic matters, soothe credit rating anxiety and meaningfully lift the gross domestic product (GDP) growth rate.

The rand, which had been technically undervalued, strengthened dramatically, levelled out as the markets reassessed the likelihood of a quick economic revival, but then recently has weakened further on US dollar strength and investors losing their appetite for emerging market (EM) risk.

What’s next?

Local factors that influence the rand, such as uncertainty around economic growth; interest rates; inflation; credit ratings; current account deficits; and government finances are all expected to remain relatively stable under the current leadership.

So, for a change, rather than domestic issues, it is likely that international developments are going to have a more significant impact on the rand in 2018/2019.

There has been a huge capital inflow to emerging markets in recent years, which is now vulnerable. Things to watch are the performance of the US economy and specifically US interest rates. If they continue to rise, less money will be directed to emerging markets.

Additionally, unexpected turbulence such as trade wars and geopolitical tensions will make emerging markets less attractive to investment. We expect weakness in the rand to be driven by global factors, because SA fundamentals should become more stable and predictable.
 
Portfolio outflows from emerging markets have accelerated on US dollar strength and the rise in US dollar bond yields. Looking through the turbulence, however, it is important to be reminded that the key downside risk is that a 10% appreciation in the dollar could cut annual net capital inflows to emerging markets by a very significant amount.

It sounds like all emerging markets are in the same boat, currency volatility-wise?

Yes and no.

Yes, all emerging market currencies are subject to any unexpected turbulence in global financial markets, which would negatively impact portfolio flows and generate currency challenges.

However, the rand has proven to be more volatile than its peers. This is, ironically, because our financial system is highly developed, with high levels of liquidity; a sound regulatory environment; electronic trading systems; dispute resolution mechanisms and well-run financial institutions.

Taken together, this attracts international currency speculators’ attention, supporting more volatility than less sophisticated currencies.

Another factor that accentuates our volatility is that our domestic environment is prone to uncertainty as SA systematically adjusts to a massive political transformation. SA's prospects can ebb and flow quite dramatically from one year to the next, unlike what is seen in any of the G20 countries.

What does this mean for South Africans?

SA has become way more import intensive and the currency has a significant influence on how goods are priced, and related changes in inflation and interest rates. This affects household budgets and our ability to plan for big purchases such as cars or overseas travel.

We also shouldn’t overlook the link between the strength of our currency and national confidence. When the rand is strong, we feel the economy is doing well, and confidence builds.

Confidence builds growth, jobs, income, spending and overall activity. Conversely, when the rand weakens, we become more negative in our outlook.

What is your advice to South Africans?

The only way you can protect yourself from the impact of currency volatility is to consistently purchase foreign currency to provide for both long-term (investment) and short-term (travel, retail) goals.

Holding foreign currency protects your global purchasing power and provides you with global choices and lifestyle options. One should be able to plan for the future no matter what the currency does.

The rand has volatility in both directions. One cannot expect the currency to be persistently below fair value and one should also avoid panicking at high inflection points.

The overriding conclusion is that timing currency transactions are incredibly difficult. Instead, it is prudent to average out offshore transactions on a regular basis.

And because we are regulated by exchange controls, which are subject to change, one should always make use of your calendar year allowance to diversify your savings abroad. As global prices rise and local incomes stagnate, it is even more critical than ever not to be isolated.

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investments  |  rand  |  forex  |  money  |  currencies
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