There are a number of factors that affect exchange rates, such as inflation rates, interest rates, investor sentiment, supply and demand, economic growth, political sensitivity and market volatility. Currency volatility is what makes forex trading so exciting and so risky. More volatility means more trading risk but also more opportunity for profit.
We have a look at what factors affect the Rand to Dollar exchange rate and what trading strategies are best to trade this exotic currency pair.
9 factors that affect the Rand to Dollar exchange rate
The level of inflation in South Africa has a direct impact on the Rand to Dollar exchange rate. In fact, inflation is one of the key economic indicators that forex traders in Africa monitor very closely.
Inflation is linked to a general increase in prices and is measured by the consumer price index. The monthly and annual inflation is calculated within a country using the percentage change in the index between two given periods.
The country with the higher inflation rate has a currency that loses value and depreciates while the country with the lower inflation rate has a currency that gains value and appreciates. Because South Africa is an emerging country with socio-economic factors that drive up its inflation rate, it’s currency is always in an inferior position to the US Dollar.
When inflation is too high in a country, interest rates go up. This has a direct impact on depreciating the currency because it’s less financially rewarding to trade it on the foreign exchange markets. When inflation is too low – known as deflation, interest rates go down. Deflation causes the currency to appreciate.
When the interest rates rise in South Africa, it becomes more attractive for US investors to deposit and save money in the country because they get a better rate of return than keeping it in the United States. Therefore, demand for the Rand rises. This is known as ‘hot money flow’ and is one of the most important factors that influences the Rand to Dollar exchange rate.
As you know, speculation largely drives forex trading. Traders who seek to make a profit on an exotic currency pair like the Rand to Dollar will not only follow economic fundamentals; they’ll closely follow investor sentiment to speculate on price movements of currency pairs. In other words, whether the forex market is feeling buoyant or jittery about the Rand to Dollar exchange rate.
Balance of payments
When there is a deficit on the current account of a country, the value of imported goods and services is greater than the value of exports. This means a country is spending more on importing goods and services than they are receiving money from exports.
This isn’t a problem when a country’s deficit is financed by a surplus on the capital account. However, if South Africa battles to attract enough capital inflows to finance the current account deficit, the value of the Rand will depreciate. Devaluation of the Rand causes inflation but it also increases demand for exports because goods and services are cheaper for US businesses.
The value of government debt in South Africa can affect the Rand to Dollar exchange rate because investors are wary that the government will default on its debt. This will cause foreign investors to sell their bonds which will cause the value of the Rand to fall even further.
Economic growth and stability
A country is not an attractive investment opportunity when it’s in a deep recession. If investors in the US expect the interest rate in South Africa to fall, the country becomes less attractive for investors to save money. Hot money generally leaves South Africa and moves to countries with higher interest rates.
When hot money flows out of South Africa, investors sell Rands and buy other stronger currencies. This causes the value of the Rand to fall further. Basically, a recession causes a fall in the value of the Rand and drives down investor confidence in South Africa.
A well-governed country that is politically stable should have a stable and strong currency. A country that is at low risk of political unrest is far more attractive to foreign investors. As a result, political stability can have a dramatic effect on the value of a country’s currency. Political turmoil and instability destabilises an economy and weakens its currency.
Take the civil unrest in South Africa in mid-2021 as an example. Rampant looting and the government’s inability to take control of the situation led to loss of life and billions of Rands in damage. The economic fallout from the civil unrest will be significant for the South African economy and this will do nothing to inspire confidence in US investors. In fact, it’ll spook them and hot money will pour out the country.
Global supply and demand
The Rand should strengthen when South African exports are popular and in demand. A strong trade industry drives up investor confidence which results in a well-performing currency. However, if there is an abundance of supply and less demand for South African export goods and services, the affect on the value of the Rand is disastrous.
Availability of money
In the same vein as supply and demand, the value of the South African Rand can be determined by how many people are trading it. When demand for the Rand increases, the value of the Rand increases. Likewise, if there is low demand and a surplus of available Rands, the value of South Africa’s currency depreciates and this negatively affects the Rand to Dollar exchange rate.
What is an exchange rate?
An exchange rate is how much it costs to exchange one currency for another. Exchange rates fluctuate constantly throughout the week as currencies are actively traded. This pushes the price up and down, similar to other assets such as gold or stocks.
An exchange rate is a determining factor of a country’s relative economic health, along with interest rates and inflation. It reflects the strength (or weakness) of one country’s currency against another one based on a number of factors.
Exchange rates are always expressed by comparing the currencies of two countries. For example:
ZAR/USD Rand-Dollar exchange rate
USD/EUR Dollar-Euro exchange rate
USD/BTC Dollar-Bitcoin exchange rate
How do you read exchange rates quoted in market analysis
The exchange rate is the rate you would exchange one country’s currency for currency of another country. For example, if you are travelling to the United States, how many US Dollars would you get for a certain amount of Rands? If you are importing goods, how much Rands would you have to pay to meet the US Dollar price of goods?
Today in South Africa, the USD/ZAR rate is 1:14.
That means you would have to have R14 in your bank account to buy one US Dollar.
If the ZAR/USD rate was 1:14, you would only need one Rand to buy 14 US Dollars.
The difference between these two examples is based on which currency is the base currency and which one is the quote currency.
If the price of a smartphone is $100 and the USDZAR exchange rate is 1:14; it would cost you R140 000 to import 100 smartphones.
What is the Rand to US Dollar currency pair?
The Rand to US Dollar (ZAR/USD) is known as an exotic currency pair in forex trading. This is because the Rand (ZAR) is an emerging market currency that carries less liquidity than a developed market currency. The US Dollar (USD) is a major currency because it carries the highest liquidity in forex trading and is by far the most popular currency to trade.
Exotic currency pairs include one major currency alongside a currency from a developing or emerging market. The Rand paired with any major currency becomes an exotic pair.
Exotic currencies are also known as alternative or third-world currencies. They can offer forex traders exciting opportunities because they have potential for higher returns than other currencies. On the flip side, exotic currencies also carry higher risk of loss.
Why forex traders like to trade exotic currency pairs
It can be expensive to trade an exotic currency because the bid-ask spread is usually large to compensate for the lack of liquidity. However, lower liquidity does offer higher opportunities for profit if traded with caution.
Exotic currencies like the Rand carry a wider spread because they carry lower liquidity than the most-traded major currencies. The major currencies are the US Dollar, British Pound, Euro, Swiss Franc, Japanese Yen, Canadian Dollar and the Australian Dollar.
The rule of thumb is forex traders like to trade major currency pairs in more volatile trading conditions because they tend to me more stable, and they trade exotic currencies when the major currency pairs are stagnant and there is low market volatility. Trading exotic pairs in volatile markets is risky and brokers usually require higher margin to cover the risk.
What are the best trading strategies to trade the Rand-US Dollar
There are three trading strategies that work best if you want to trade an exotic currency pair like the Rand to Dollar. Exotics are more volatile and less liquid than major pairs like the USD/EUR and GBP/USD but they do offer opportunities for reward if traded with caution.
Trend trading is a popular trading strategy for exotic currency pairs. Forex traders identify an overall trend and go either long or short on a position, depending on whether the trend is bullish or bearish. A trend trading strategy relies on technical analysis rather than fundamental analysis.
Breakout trading is a popular strategy for trading exotic currency pairs but you need to be careful that a breakout is not a false breakout. A breakout trading strategy relies on both fundamental and technical analysis to capitalise on price movements once it breaks through a historical level of support and resistance. The most popular chart patterns to use for breakout trading are pennants, wedges and ascending and descending triangles.
Range trading is where a forex trader seeks to profit from the peaks and troughs within the range by going either long or short on a position. Range trading involves trading within a set range of support and resistance. Traders who use the range trading strategy to trade an exotic pair like the Rand to Dollar couple use chart patterns such as wedges and triangles to speculate on price movements.
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