South African Rand is on the Rise, and More gains are Possible say Investec

Foreign exchange trade

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- SA Rand has gained on easing trade risks

- Investec's base case is for the uptrend to continue

- SA to hold onto to its investment rating

The Rand has strengthened on the back of an improvement in investor sentiment towards emerging markets (EM) and we are told by one of South Africa's leading investment banks that further advances are possible.

Analysts at Investec see a 40% chance the Rand will rise into year-end, but be warned there is also a non-neglible risk set at 35% that the currency enters a deeper trend of decline.

The call by Investec comes as the South African unit enjoys a solid run that has seen it advance against all members of the G10 currency complex over the course of the past month with a 5.4% gain being registered against the Pound and a 4.6% gain bein registered against the Dollar.

Against the Euro the Rand is 6% higher.

Part of a reason for this recovery is a thawing of previously frosty relations between Washington and Beijing suggesting the worst excesses of a trade war are now likely to be averted.

Both president's Xi Jinping and Donald Trump have indicated they are open to discussing a trade deal.  

The Chinese leader has said China intends to cut import tariffs and crack down on intellectual property theft, whilst Trump has said he wants to speak with Xi at the G20, is open to discussing a deal, and has asked his officials to start drawing one up. So far so good.

The Rand, meanwhile, is up over 2.8% versus the Pound in November alone, trading in the at 18.20s currently, and up an even greater 5.8% versus the weaker US Dollar, against which it is currently trading in the 13.90s.

The big question now is whether the currency can hold onto these gains.

Whilst the outlook for global trade appears to be improving there remains a question mark over whether or not domestic headwinds could be a spoiler.

Most recently the Rand was hit by the negative reaction to the government's Medium Term Budget Policy Statement (MTBPS) as well as fears about the country's credit rating which sits at Baa3, only one notch above the minimum for investment grade.  

"The Rand’s retracement since September has had a few false starts, most recently SA’s MTBPS which saw the yield on the R186 reach 9.45%, with Moody’s deeming this mini-Budget 'credit negative'," says Annabel Bishop, analyst for Investec bank.

If implemented in full the MTBPS would be expected to widen the budget deficit to 4.2% in 2019, followed by an average of about 4.0% over coming years. This compares unfavourably to government projections back in February which had the deficit falling from 4.3% in 2017 to 3.6% in 2018 and stabilising at 3.5% in 2020.

Clearly, with the country's credit rating sitting perilously one notch above the minimum for investment grade there is a risk a widening budget deficit could pitch the country's debt into 'junk' status.

Investec's base case, however, is for this not to happen.

"We continue to expect that Moody’s will downgrade SA’s outlook to negative this year, but keep the country rating on the last investment grade level," says Bishop.

Whilst an outlook downgrade is typically followed by a rating downgrade this is not certain to happen in the case of South Africa.


Forecasts for the Rand

Investec's base case expectation, with a 40% probability attached, is for SA to keep its investment grade rating.

As far as broader economic growth goes, the expected outcome is for the economy to grow by 2.0% in 2019 and 3.0% in 2023. This is substantially higher than the current -0.7% annualized growth rate in Q2 2018 and the -2.6% registered in Q1. The country is in fact currently in a technical recession.

The possible forced expropriation of land for redistributive purposes is however a risk factor for financial markets.

Investors are fearful the government may suddenly seize their assets and if the policy were implemented in an unadulterated form it would lead to massive cuts in foreign investment and weigh on the Rand.

In their base case scenario, Investec see the policy as being implemented on a limited basis, however, to encompass only disused government and agricultural sector land resulting in little demonstrable impact on investor sentiment.

As far as the macroeconomic backdrop goes, Investec expect a global environment of "neutral to global risk-on" and "Sedate monetary policy normalisation."

and for the Rand to rise marginally to 13.70 versus the Dollar by the end of Q4 2018.  

They then see the exchange rate falling to 12.80 in Q1, 13.30 in Q2, 13.80 in Q3 and 12.75 in Q4.

Investec's next most probable scenario (35%) sees the Rand declining and USD/ZAR going up to 16.20 by the end of 2018.

USD/ZAR is then seen rising to 17.00 in Q1, 18.00 in Q2, 18.50 in Q3 and 19.60 in Q4.

This 'down case' scenario for the Rand would encompass a full credit rating downgrade by Moody's to sub-investment grade which would lead to a severe devaluation of the Rand.

The policy of forced expropriation of land would be implemented on a much wider basis to include private commercial property and productive land, which would be taken by the government without compensation.

The global macro scenario in the 'down case' would be more risk-off sharp global economic slowdown and a stronger US Dollar on the back of a more aggressive normalisation strategy from the Federal Reserve.

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