Rand Exchange Rates: What Would Happen if Bonds Were Downgraded to Junk?

"We remind that South African assets are already trading as if the country has lost investment grade status." - RMB.

The rand has touched all-time lows against the British pound as markets sell emerging market currencies.

Spare a thought for the Brazilian Real though – the BRL is the worst performing emerging market currency having declined 32%.

The latest leg lower in BRL came as ratings agency S&P decided to slash their rating on Brazilian debt to ‘junk’ status.

S&P cut Brazil's rating from BBB-minus to BB-plus which flags substantial investment risks to global investors. Risk management rules at the world’s most important institutions mean fund managers are no longer able to invest in Brazilian government debt.

S&P raised Brazil to investment grade back in 2008.

What of the South African Rand?

Will South Africa follow Brazil, and what does it mean for the rand?

Analyst John Cairns at RMB in Johannesburg says his clients regularly ask us about the implication of moving into junk status.

“Brazil gives us a good example. The real only lost 3% when it opened yesterday and actually managed to recover some lost ground later in the day. This is hardly a major slide,” notes Cairns.

The RMB analyst notes that the true impact, however, is hidden in the markets prior discounting of the event: USD/BRL went from 2.65 at the beginning of the year to 3.78 just before the downgrade - a rise of 42%!

“In this regard, we remind that South African assets are already trading as if the country has lost investment grade status, i.e. it’s already mostly in the price,” says Cairns.

Latest Pound / SA Rand Exchange Rates

	Live: 22.6363▼ -0.07% 12 Month Best: 25.4721
*Your Bank's Retail Rate	21.8667 - 21.9572
**Independent Specialist	22.3194 - 22.41 Find out why this is a better rate

* Bank rates according to latest IMTI data.

** RationalFX dealing desk quotation.

 

Rand: How Will it React to the Fed?

Near-term direction in ZAR rests with events in the United States.

“The biggest uncertainty is whether the Fed will hike or not on Thursday. The Fed futures market currently prices a 23% probability,” notes RMB’s Cairns in a note to clients on Monday.

Analysts, however, are split almost exactly 50-50. At this stage, even the Fed voting members probably do not know the way the decision will go.

Then there is uncertainty over how markets will react.

Over the past few months the trade was clear: a higher Fed rate was seen as a huge negative for the rand.

“Recently, however, various parties have argued that it is the uncertainty over the decision that is the negative (rather than the risks of a hike), suggesting that we could get a counter-intuitive rand recovery if they vote to increase rates,” says Cairns.

RMB’s take is to expect the normal relationship - USD/ZAR to spike immediately if they hike, but then the counterargument to limit the fallout and generate some mild recovery.

The most important factor in guiding the Fed’s decision this week will be the fallout of the Chinese slowdown on US and global growth.

Sunday’s data releases in China (industrial output) disappointed, and in the short term China will continue to provide the main market theme.

The dollar’s sluggish performance of late is a reflection of markets’ lower conviction in the Fed raising interest rates on Thursday.

Uncertainty is sky high for the dollar given the big dose of information the Fed will release.

In addition to its rate decision, the Fed will also weigh in on where it sees the economy and interest rates headed over the coming year.

The dollar would be at risk of a tumble if the Fed should sketch a lower trajectory of rate hikes over the coming year.