“This quarter has the potential to be the most volatile one for the year and could be a bumpy ride towards Christmas.”
The coming quarter could be as volatile as it gets for those dealing in South African Rand, according to the team at TreasuryOne Treasury Services, as an acceleration of global growth risks seeing high yield currencies fall from favour among investors.
With expectations of further rate hikes from the Fed moderating progressively throughout the year, and the greenback subsequently falling to the bottom of the G10 basket, high yielding currencies have been in demand during 2017.
“There have been cabinet reshuffles, political unease, and a rating downgrade, to name a few, and still, the Rand is holding on,” says TreasuryOne, in its latest review of the markets.
The South African Rand gained 6.2% on the Dollar during the first nine months of the year and has held its own against Sterling, the Yen and the Swiss Franc, confining losses to the low single digits.
This is despite a litany of domestic political and economic headwinds, as well as the tall shadow of the South African Reserve Bank (SARB) having born down on it with its first rate cut in more than five years.
“Truth be told the international landscape has been geared toward Emerging Markets (EM) this year as investors have shrugged off perceived ideas of risk associated with EM’s and have been on their best yield seeking behavior,” says TreasuryOne.
The Rand ceded ground to the US Dollar Tuesday, with the USD/ZAR exchange rate rising 0.58% to 13.0217. It dropped by a lesser extent against the even lower yielding Swiss Franc, with the CHF/ZAR exchange rate rising by just 0.14% to 13.5680.
Image showing US Dollar to Rand exchange rate during 2017. Source: Pound Sterling Live & TradingView.
“The long-term worry is that with the global economy picking up investors might chase growth in the next few years, which South Africa is desperately lacking, and we could see some of the yield trading disappearing and the Rand coming under pressure in the long term,” says TreasuryOne.
The South African economy emerged from the shallows of a technical recession during the second quarter, with economic growth coming it at 2.5% on an annualised basis.
“We are seeing a dichotomy developing in the markets especially in the South African market where we have a weaker US dollar on one side which would indicate EM and ultimately Rand strength, but then we have local issues such as weak growth, political instability and credit ratings that could hamper the Rand from going stronger,” says TreasuryOne. “This quarter has the potential to be the most volatile one for the year and could be a bumpy ride towards Christmas.”
SARB: Once More Into The Breach?
While the economy may have emerged from recession in the second quarter, and the worst of the political crisis seems to have passed, a faster than expected fall in inflation could mean the SARB cut rates again during the coming months.
“Inflation has likely peaked and the economic growth outlook is anemic, but we think the SARB will ease once more this year (25bp cut in November), following the surprise rate cut in July,” says Saad Siddiqui, a strategist at JPMorgan.
Siddiqui notes a favourable environment for high yielding currencies but, adding to expectations of another rate cut from the SARB, says the Rand’s yield isn’t enough to compensate speculative investors for fiscal and ratings risks, an unsettling balance of payments position and structural growth challenges. Nonetheless, the Rand isn’t exactly expensive either.
“USDZAR is now fair on our shorter-term intuitive model of CDS and commodity prices, from 4.5% cheap at the start of August. On our long-term REER model (based on real interest rates, commodities, government debt and current account balance), the rand is around fair value,” Siddiqui wrote in a note this week.