Fed pause supports rand exchange rate amid geopolitical risks and inflation

Despite increased investor confidence following the recent Reserve Bank decision, ongoing tensions in the Middle East continue to create uncertainty for the South African bond market.

Bond Market Status

The South African bond market has regained some stability after the South African Reserve Bank decided to keep interest rates unchanged. However, the geopolitical situation in the Middle East and the US Federal Reserve's decision continue to negatively affect investor sentiment.

Investec Chief Economist Annabel Bishop noted significant volatility in South African bond yields in July. This volatility was triggered by the escalation of the conflict in the Middle East, prompting investors to withdraw funds from emerging market assets.

Yield Dynamics and Policy

Bishop reported that the yield on ten-year benchmark bonds rose from 8.32% at the beginning of the second week of July to 8.93% due to the worsening crisis in the Middle East mid-month. Nevertheless, market conditions improved after the Monetary Policy Committee's (MPC) decision last week.

Keeping the MPC rate stable helped bring the yield down to 8.66% at the end of last week, with a trend towards 8.50%, although there has been noticeable instability this year, with yields dropping below 8.00% before the Middle East war.

Increased Investor Confidence

In Bishop's view, the Reserve Bank's measured approach strengthened investor confidence. She emphasized that 'the restrained tone of the MPC statement in July improved investor sentiment,' and also mentioned that the manager noted at the beginning of the month that 'the past two years have led to a significant re-rating of South Africa.'

Furthermore, the improvement in South Africa's fiscal position boosted investor confidence. Credit rating upgrades were received, and the country exited the FATF grey list. Financially, South Africa has transformed from a 'problem child' into a rare example of a country where sovereign debt stabilization is expected this year.

Inflation and External Risks

Bishop forecasts that inflation will remain relatively controlled despite recent volatility in global energy markets. Since there are unlikely to be significant changes in fuel prices in August, slight inflationary pressure is expected in the short term.

Although consumer inflation reached 5.0% year-on-year in June, further acceleration in July is unlikely due to lower fuel and electricity costs. Bishop suggested that CPI inflation could fall below 5.0% year-on-year in July, considering the rise in gasoline prices a year ago compared to the drop this month.

However, international events continue to pose risks to the local market. Following the resumption of the conflict in the Middle East, foreign investors reduced their stake in South African government bonds. Foreigners sold bonds worth R19.8 billion as of the 17th of the month, contrasting with net foreign purchases of R54.3 billion on the same date last year.

International Organization Warnings

Bishop also cited warnings from international institutions regarding the potential economic consequences of prolonged geopolitical instability. The World Bank warned that the Middle East conflict could slow global growth to its lowest level since the Covid-19 pandemic due to rising energy prices, increased inflation, and higher borrowing costs.

The International Monetary Fund also cautioned that 'high public debt in several major economies puts sovereign markets at risk of fiscal sustainability reassessment, especially if other adverse shocks occur simultaneously.'

Analyst Comments

Meanwhile, Bianca Botess, Managing Director of Citadel Global, noted that markets moved again due to events in the Middle East after reports that Iran had launched new strikes against the United States overnight. Botess stated that it resembled a déjà vu, as Iran attacked the United States at night, jeopardizing a new ceasefire agreement.

She pointed out the mixed dynamics in the US markets: the S&P 500 index closed slightly higher, the Nasdaq fell almost 1%, and the Dow Jones Industrial Average reached new record highs. Asian markets also felt pressure, particularly the technology-focused KOSPI index, while oil prices rose nearly 4%, reaching around $85 per barrel, in response to heightened geopolitical uncertainty.

Botess added that 'this is the day X for the Federal Reserve's interest rate announcement, which will be closely watched.' Despite the increased uncertainty, the rand remained relatively stable, trading at R16.74 against the US dollar, R19.08 against the euro, and R22.26 against the British pound on Wednesday.

The Rand strengthened on Monday due to the easing of geopolitical tensions between the United States and Iran, as well as the weakening of the US dollar, which boosted investor confidence following an unexpected decision by the Sarb on interest rates last week.

Currency Market Dynamics

At the beginning of the week, the South African Rand gained strength as reduced geopolitical tension in the Middle East and a weaker US dollar helped markets recover from fluctuations caused by the South African Reserve Bank's (Sarb) decision to keep interest rates unchanged.

After a brief dip to R16.98 against the US dollar on Friday, when investors reacted to the Monetary Policy Committee's unexpected decision to maintain the repo rate at 7%, the local currency recovered to approximately R16.70 on Monday morning.

Analysis of Rand Strengthening Reasons

Investec Chief Economist Annabel Bishop noted that the sell-off was largely driven by markets abandoning expectations of a rate hike. Bishop explained that the Rand reached R16.98 to the US dollar on Friday, then rose to R17.00 as markets priced in the cancellation of the expected 25 basis point hike by the MPC on Thursday.

She added that such a weakening is unlikely to persist. On Monday, the Rand was at R16.70 to the US dollar, with the national currency's movement being driven by domestic events, unlike the usual factors associated with the US dollar's movement and changes in risk appetite in global financial markets.

Bishop also pointed out that the decline in the US dollar's exchange rate contributed to the Rand's stabilization. The US Dollar Index fell from 100.69 last Thursday to 91.44 on Monday, helping the local currency avoid further depreciation.

Impact of Diplomatic Events

Despite the recovery, Bishop warned that the Rand remains vulnerable to shifts in global investor sentiment, as it remains volatile and risks further weakening, especially with changes in global risk. Markets also found support after reports that the United States and Iran had suspended military actions and resumed talks over the weekend, reducing fears of a wider conflict in the Middle East.

Bianca Botes, Managing Director at Citadel Global, stated that investors reacted positively to the diplomatic developments. Analysts suggest that the resumption of talks could lead to reduced tension in the Middle East, to which investors are responding positively.

Global Markets and Commodities Overview

Although Wall Street's stock market closed mixed on Friday, with the S&P 500 nearly unchanged and the Nasdaq down 1.7%, market sentiment improved ahead of the start of the new trading week. Botes noted that early-week futures were positive, reflecting the general improvement in sentiment driven by reduced geopolitical tension.

Asian markets also opened moderately higher as investors anticipated a busy week determined by corporate earnings and the latest decision by the US Federal Reserve on interest rates. Botes emphasized that market observers are paying close attention to the upcoming Fed announcement, which should provide crucial information on the future trajectory of monetary policy in the United States.

The decrease in geopolitical tension also put downward pressure on oil prices after several weeks of sharp increases. Bishop reported that Brent crude oil fell below the $90 per barrel mark, reaching $87.9 per barrel, and remains volatile. Meanwhile, the impact on fuel prices in South Africa for August remained virtually unchanged, as international petroleum product prices also declined.

Meanwhile, gold continued its recent rise as investors continued to seek safe-haven assets. Botes reported that gold showed significant growth, rising 0.88% to $4088 per ounce. This surge is linked to the perceived stability that talks between Iran and the US might bring, prompting investors to flock to precious metals as a refuge.

Regulator Comments and Forecasts

Bishop also noted that financial markets received relief from the tone of the Monetary Policy Committee's statement last week. Overall, financial markets calmed down thanks to the central bank's neutral or dovish tone, which provided more support to the economic growth forecast than expected, favorably impacting the investment climate.

She also mentioned that South African government bond yields decreased after the MPC lowered the inflation forecast and signaled a softer path for interest rates than many investors anticipated. However, Bishop warned that uncertainty remains high. She forecasts a slowdown in growth in the second and third quarters of this year.

The central bank outlined two possible scenarios: the base case is that the economy will begin to recover in the second half of the year as the shock subsides. But she cautioned that if inflation remains high and spreads across the economy, the 'adverse scenario' suggests persistently high inflation, which would require additional rate hikes this year and an extension of the restrictive policy period.

For now, investors will closely monitor developments in the Middle East, as well as the Federal Reserve's decision expected later this week, as both factors are expected to influence the direction of global financial markets, the Rand, and commodity prices.

The Reserve Bank's Monetary Policy Committee (MPC) decision to keep the repo rate at 7.0% was unexpected, despite inflation rising from 4.5% in May 2026 to 5.0% in June. The MPC explained this by noting that economic growth remains under pressure, mentioning risks of slowing growth in its statement.

MPC Forecasts and Arguments

The Committee indicated that the forecast derived from the Quarterly Projection Model (QPM) suggests that the key interest rate will remain relatively stable for the remainder of the year. According to the model, rate cuts are expected later when inflation drops to 3%, and rates will adjust to a neutral level. Furthermore, the MPC asserted that the stronger rand since the beginning of the year helped reduce fuel prices in July, and food inflation remained moderate, increasing by only 1.4%, while further significant declines in fuel prices were anticipated.

Rising Inflationary Pressure

The MPC's decision to maintain the repo rate unchanged appears contradictory, as the statement acknowledged that services inflation remains a complex issue, with most components exceeding the 3% mark, including housing, transport, and insurance. The MPC also noted that various core inflation indicators point to intensifying inflationary pressures. Moreover, the latest survey by the Bureau of Economic Research showed an increase in inflation expectations, with short-term expectations being higher than long-term ones. All groups surveyed within this bureau predicted higher inflation, with the largest increase recorded among trade unions.

Financial Market Reaction

Despite the MPC's choice to keep interest rates unchanged, financial markets demonstrated disagreement. Following the MPC announcement, the rand sharply depreciated against the US dollar, euro, and British pound, reaching R16.80 to the dollar on Thursday and trading at a weak R16.96 to the dollar on Friday, closing the week at R16.83 to the dollar. The oil price shock situation also continued last week: disruptions on three fronts in the Strait of Hormuz, Red Sea, and Black Sea pushed Brent crude oil prices above $100 per barrel on Thursday. Although prices slightly decreased to approximately $98 per barrel, leading to a modest recovery in stock markets and lower bond yields on Friday, global markets remained under pressure.

South African Stock Market Dynamics

On the JSE, the All Share Index (ALSI) lost 1.8% on Friday following the MPC's decision and the sharp rise in oil prices. Although the price of gold recovered from $4,007 last Monday to $4,073 on Friday, and platinum and palladium also strengthened, most JSE indices ended the week lower. Ultimately, the ALSI was nearly flat, showing a gain of only 0.15%, while remaining 14.3% below the level recorded before the US attack on Iran. A similar trend is observed across most major global indices.

Fuel Price Forecast for August

Although the initial recovery of petrol prices to 3.57 per liter and diesel to 5.10 per liter looked promising at the beginning of July, the sharp rise in oil prices from $76 to $96 per barrel over the last four weeks, combined with the rand weakening by more than 40 cents last week, ruled out any prospects of fuel price decreases in August. By last Thursday, the recovery in diesel prices had already shrunk to 110 cents per liter. Meanwhile, 95 ULP petrol still showed a recovery of 41 cents per liter, but prices for both fuels are expected to rise next month, with the increase in diesel likely being sharper.

Outlook for the Coming Week

This week, domestic and global financial markets will focus on the Federal Open Market Committee (FOMC) of the US Federal Reserve's interest rate decision, which is scheduled for Wednesday. The general consensus suggests that this benchmark rate will remain unchanged at 3.75%. If the FOMC decides to raise interest rates, the rand, bonds, and South African stocks are likely to come under significant pressure. The Bank of England (BoE) is expected to announce its interest rate decision on Thursday, with markets predicting it will also leave rates unchanged at 3.75%. On Thursday, the US will release personal income and expenditure data, and the Eurozone plans to publish its June unemployment rate on the same day. Locally, Statistics South Africa (Stats SA) will publish government budget balance and June Producer Price Index (PPI) data on Thursday. The South African Reserve Bank will publish South Africa's trade balance on Friday.