At the beginning of last year it was speculated that, “The chance of a reversal [in the rand] has also increased this year as the currency is well into overvalued territory… Increased risk aversion, particularly from Europe, could accelerate this trend”. The rand did have a turbulent year in 2011, losing ground against most currencies. The main reason for the weakness was renewed risk aversion due to a worsening in the Eurozone crisis and disappointment over global economic prospects.

After a shaky start to the year the rand settled into a relatively narrow trading range until a renewal of global jitters in July and August pushed it significantly weaker. Markets began to realise that the Eurozone crisis was far from over and that there was a significant danger that it could spread to the “too big to fail and too big to support” category of countries in Europe, such as Italy and perhaps even France. Spreads on Italian 5-year credit default swaps (CDS) went from 133 basis points (bp) in early July to nearly 500 bp in late September as participants scrambled to cover against the unthinkable. During this period the currency lost 16 percent against the trade-weighted basket, accounting for most of the cumulative 17.6 percent depreciation for the year.

The second concern to markets was the general loss of momentum in the global economy. As usual, the year had started with optimism over the outlook and a feeling that trend growth would at last start to resume. The combined natural and nuclear disaster in Japan in March led to a sudden contraction in Japanese economic production as well as supply chain disruptions across the globe. However, it was felt that the Japanese economy would bounce back quickly and that the global economy would strengthen in the second half of the year. Japan did stage a remarkable comeback, but this was insufficient to offset a more general slowdown elsewhere. This included the United States, which was also embroiled in a fiscal battle (to raise the debt ceiling and come up with a bipartisan plan to cut the deficit over the next few years) and still had structural issues in the housing, labour and credit markets to contend with.

China too started showing signs of slowing down and stress in certain areas such as the property market. Against this background, commodity prices were generally weak in 2011, particularly in the second half of the year as gloomier sentiment set in. Two exceptions were oil and gold, which both performed strongly until September when they corrected from elevated levels. Prospects for 2012 are less clear than they were at the start of 2011. The currency is much closer to fair value than it was at the start of last year, suggesting that most of the expected correction has already taken place. However, all purchasing power parity estimates (which use inflation differentials to estimate competitiveness losses and gains) have their limitations and the rand often deviates significantly from theoretical fair value over extended periods.

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