RISK MANAGEMENT | 24 FEBRUARY 2022 Why isn’t the Rand worth what it’s worth? Absa | Corporate and Investment Banking > Insights and Events > Why isn’t the Rand worth what it’s worth? Mike Keenan Head of Fixed Incomeand Currency Research SHARE There’s often a gap between the fair value of the rand and the currency’s real-world value. Why is that? Something strange happened to the ruble in January 2021. The Russian currency had been trading at a relatively steady RUB74 to the USD dollar, when suddenly – amid whispers of war in Ukraine – it spiked to RUB79. There were talks of an invasion, and troops were gathering on both sides of the border, but no shots had been fired (yet). Why, then, was the ruble weakening? Currency values are often influenced by events that haven’t happened yet. As Mike Keenan, Head of Fixed Income and Currency Research at Absa CIB, explains, this is known as the risk being “priced in”. “Thanks to technology, markets today have more perfect information than ever before,” he says. “The market is well aware of potential eventualities well ahead of time, and traders are quick to price in that risk. It could be that there’s an impending war in Russia, or the possibility that the United States Federal Reserve might hike its interest rates. Whatever the risk, the minute people start talking about it, traders will start pricing it in.” Another example was the emergence of the Omicron variant. “The minute traders heard that South Africa had a new Covid-19 strain, the rand got butchered,” says Keenan. “When that nervousness dissipated, people started buying the rand again. But when those headlines initially hit, investors moved quickly to reduce their exposure to South Africa.” Timing the market The reason investors act like that is, of course, to make a profit by selling the currency while it’s still strong, and buying it again when the risk event happens and the currency weakens. But they have to get the timing right. “If they wait until the currency has weakened before they cut their position, they’re not going to make the profit they want,” says Keenan. “Think of it as a horse race. You can’t bet on the horse once the race has been run. You have to get your bets in beforehand.” Timing the market is best left to the professionals. “By the time the man in the street finds out about the risk and tries to act, the currency will already be a lot weaker,” he warns. “The exchange rate market is actively traded 24/7, it’s more liquid than any other market in the world and it’s worth USD5-trillion. It’s huge, and it moves quickly. So unless you have access to Bloomberg or Reuters terminals, you won’t be able to time the rand based on the headlines you’re reading. The vast majority of the time, you’ll simply react too slowly.” A good example of that was “Nenegate” on 9 December 2015. “Everyone in South Africa was sitting on the beach enjoying their holiday when the Minister of Finance got fired,” Keenan recalls. “By the time you got back to civilisation in January and said, ‘I’m taking all my money offshore’, the rand had already weakened sharply. You’d then have been selling at the worst possible time.” Fair value vs real value This dynamic helps explain the gap that often exists between the fair value of the rand (as calculated by Absa’s currency team) and the exchange rate one gets through foreign exchange (FX). “It’s a large part of it,” Keenan says. “That’s why it’s important to look at what the models are saying. For instance, if the Purchasing Power Parity model says the rand is fairly valued at R14.50 and in reality it’s trading at R16.00, that gives you a sense of where it is relative to its fair value. You want to be buying the currency when it is significantly above its fair value, and selling when it is significantly below. With that approach you’ll move away from trying to time the market and into a space where you’re establishing when there is value and when there isn’t.” And in the absence of trader terminals, constant news headlines and people on the ground, it’s a sensible basis on which to build your FX plans. Contact us To access leading foreign exchange expertise for your business, corporate and institutional needs. Mike KeenanHead of Fixed Income and Currency Research https://cib.absa.africa/wp-content/uploads/2020/07/file_example_MP3_700KB.mp3 Related Articles RISK MANAGEMENT London Investment week 2024 As we mark 30 years of democracy in South Africa, the London Investment Week provides a dynamic platform for fostering deeper collaboration between South Africa and the United Kingdom. Read more RISK MANAGEMENT Making the case for East Africa With opportunities for infrastructure development, a wealth of natural resources and a growing consumer market, East Africa is an increasingly attractive investment option. Read more RISK MANAGEMENT FX Hedging in the Age of Big Data and AI Digital technologies like AI and machine learning highlight why corporate treasurers need a data-enabled FX provider. Read more
