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The rand benefited from the sell-off of the dollar in trade on Thursday (Oct 1), adding a percentage against the dollar in one stage.
“Hopes for additional stimulus from the US government in the form of a Covid-19 aid package added pressure on the dollar yesterday,” said Bianca Botes, CEO of Peregrine Treasury Solutions.
The local unit has endured volatile trade in recent weeks, beating record GDP data and dazzling unemployment figures showing 2.2 million people lost their jobs, leaving employees at 14.1 million.
Momentum Investments said in a note that the country’s already weak growth results have been hampered by the virus slump. In response to a decline in the daily rate of new Covid-19 cases and a slowdown in deaths, lockdown restrictions have been further relaxed, allowing most of the economy to resume activities.
“However, persistent unemployment and bankruptcies, especially concentrated in small and medium-sized companies, as well as continued power supply limitations will slow down the recovery. Low growth has limited South Africa’s ability to cope with a growing budget deficit and a growing debt burden.
“In our opinion, a deteriorating fiscal situation and hampered structural reform efforts will affect the outlook for sovereign ratings.”
Despite the provisional rand weakness anticipated by fiscal vulnerabilities in the upcoming October 2020 medium-term budget and sovereign rating risks, the pass-through to the inflation basket is expected to remain silent due to a wide gap of production and available capacity, economists at Momentum Investments said.
- Dollar / Rand: R16.64 (-0.75%)
- Pound / Rand: R21.35 (-1.44%)
- Euro / Rand: R19.53 (-0.57%)
So where does this leave the rand?
George Herman, Citadel’s chief investment officer, noted that the rand started the year at R14.00 / $, with the group’s year-end target at that time at R16.50.
“This was based on the worsening of SA’s credit metrics and an inevitable downgrade of its credit rating to underinvestment grade,” he said.
“The Covid-19 pandemic arrived and decimated all risk assets in March, although most have remarkably recovered since then thanks to massive intervention by the world central bank, monetary easing and fiscal stimulus.
“It is exactly this big monetary push from the Federal Reserve that has triggered the dollar, allowing commodities to improve and thus emerging market currencies and equity markets to rebound. The rand was no exception, improving from the R19.00 level to around R16.00 between March and June. “
What’s on the horizon?
South Africa has been downgraded and foreigners have become slow but steady sellers of South African bonds, Herman said. Foreign holdings of SA bonds are at their lowest levels in decades, eliminating an important financial avenue for the bond market and putting enormous pressure on domestic funding sources.
“Fortunately, so far we have seen a very benign global interest rate and therefore a bond environment,” he said.
The country’s sovereign debt metrics have deteriorated materially and rapidly, the analyst emphasized. South Africa’s strict lockdown measures have decimated the treasury and the largest deficits in history are looming. So far, this reality has not materialized either in the bond market or in the currency because:
- Many other emerging markets face the exact same problem, so on a relative basis, not much has changed.
- The SARB acted quickly and firmly, not only by slashing rates, but by physically intervening in the bond market.
- SA received large loans from global financial institutions, at favorable rates, alleviating short-term financing pressures.
Herman said that Finance Minister Tito Mboweni has to take the stage during October with MTBPS, which is the traditional policy-setting framework, rather than a detailed budget.
“We know that the government has indicated that its objective is to rebuild and transform the economy at once, so this specific MTBPS is significant. Unfortunately, despite his aloe by his side and his brilliant African analogies with crocodiles and hippos, the minister will not be able to avoid the harsh realities of a record budget deficit and a worsening credit profile.
“The IMF loan adds a new dimension to our credit dynamics, since it is short-term in nature, is denominated in dollars, and is spent on current expenses around the pandemic. This capital is not invested in any expansion of economic capacity, but is poured purely into the economy as short-term pain relief. However, it must be reimbursed, in dollars, from the normal budget, after three years.
“This is a new crocodile in Mr. Mboweni’s pool,” Herman said.
He said the government’s inability to reject funding from faltering state-owned companies keeps a very strong ball and chain around the fiscus’s ankle. It highlights the political inability to implement the structural reforms promised for so long and yet to be seen. “Global creditors are taking notice,” he said.
In the short term, the US The electoral debates will continue to occupy the focus of investors, since there will be implications for the November vote.
“With short-term dollar weakness still on the horizon, the original year-end forecast of R16.50 / $ 2020 seems reasonable,” Herman said.
He said 2021 promises to be a year of global recovery, so benign growth and a commodity environment should support the rand overall.
The phases of global risk sentiment will support the rand and a test below 16.00 is highly likely.
“However, if the rand is considered a fair value of around R16.50 at the end of 2020, it is difficult to see a significant and sustained rally beyond R15.50 during the year.”
He said the probability of less than R16.00 by the end of 2021 is 10%.
Interest rate parity is like gravity in currency markets, so the rand faces at least 75 cents of weakening due to this factor alone, putting the equivalent fair value by the end of 2021 around R17. 25, Herman said.
He said the probability of the rand between R16.50 and R18.00 at the end of 2021 is 50%.
“Poor credit metrics are sure to materialize eventually,” he continued. 2021 may still be early, but the first repayment of an IMF loan is fast approaching.
“With SA’s weak growth dynamics, a comfortable resolution driven by growth in debt metrics is highly unlikely, if not nearly impossible,” he said.
Herman said the probability that the rand will be weaker than R18.00 by the end of 2021 is 40%.
BNP Paribas, for its part, said the rand is likely to end the year at R16.50 against the dollar. “South Africa is expected to lag behind its emerging market peers in terms of peace of economic recovery, but its balance of payments has recently turned favorable for the ZAR, with adjustments in its trade balance, slowdown in portfolio outflows and a smaller deficit on the primary income side.
“Improving the terms of trade, in our opinion, will have a prolonged positive impact on the currency,” he said in a note this week.
Wayne McCurrie of First National Bank – Wealth and Investments has a similar outlook for the local unit.
We all know the 2.2 million jobs lost in the second quarter. Our estimates are + – 1.2 million jobs lost at the end of the year. Credit to the private sector slowed to 3.9% from 5.1% in August.
– Wayne McCurrie (@WayneMcCurrie) September 30, 2020
Goldman Sachs has maintained a bullish stance on the rand, calling it “deeply undervalued.”
Goldman expects an even longer recovery for the local unit in the latest quarter, to R 15.80 by year-end, according to PoundSterlinglive.
“Both the rand and the ruble seem to have more room to run, and the ZAR stands out as deeply undervalued by standard metrics,” said Kamakshya Trivedi, head of emerging markets macro strategy at Goldman Sachs.
“However, given significant domestic risks, including South Africa’s October midterm budget announcement for the rand, and a combination of still volatile political headwinds and slowly fading macroeconomic tailwinds for the ruble, The key question for each coin is whether the global level Betas can (eventually) overcome domestic headwinds.
“On this front, we are optimistic; with Chinese data, to which ZAR is sensitive, suggesting continued recovery. “
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