The rand profited from the dollar sell-off in trade on Thursday (1 October), adding a percent against the greenback at one stage.
“Hopes for additional stimulus from the US government in the form of a Covid-19 relief package added pressure to the greenback yesterday,” said Bianca Botes, executive director at Peregrine Treasury Solutions.
The local unit has endured volatile trade in recent weeks, overcoming record GDP data, and eye-watering unemployment numbers showing that 2.2 million people lost their jobs, leaving the employed at 14.1 million.
Momentum Investments said in a note that the country’s already weak growth outcomes have been hobbled by the virus slump. In response to an easing in the daily rate of new Covid-19 cases and a slowing in fatalities, lockdown restrictions have eased further, allowing for the bulk of the economy to resume activities.
“Nevertheless, sticky unemployment and bankruptcies, particularly concentrated in small and medium businesses, as well as ongoing electricity supply constraints will dampen the recovery. Poor growth has limited South Africa’s ability to deal with a growing budget deficit and a rising debt burden.
“A deteriorating fiscal position and stymied structural reform efforts will weigh on the sovereign ratings outlook, in our view.”
Despite interim rand weakness anticipated on fiscal vulnerabilities in the upcoming October 2020 medium-term budget and sovereign rating risks, pass through to the inflation basket is expected to remain muted on a wide output gap and spare 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, chief investment officer at Citadel 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 predicated on SA’s worsening credit metrics and an inevitable credit downgrade to sub-investment grade,” he said.
“The Covid-19 pandemic arrived and decimated all risk assets in March – although most have recovered markedly since then on the back of enormous global central bank intervention, monetary relaxation and fiscal stimulus.
“It is exactly this large monetary impulse from the Federal Reserve that has tripped up the dollar, allowing commodities to improve and hence emerging market currencies and equity markets to rally. The rand was no exception and improved from the R19.00 level to near R16.00 between March and June.”
What’s on the horizon?
South Africa has been downgraded and foreigners have turned into slow but consistent sellers of SA bonds, said Herman. Foreign holdings of SA bonds are at their lowest levels in decades, removing an important finance avenue for the bond market and placing enormous stress on domestic funding sources.
“Fortunately, until now we have seen a very benign global interest rate and hence bond environment,” he said.
The country’s sovereign debt metrics have worsened materially and rapidly, the analyst stressed. South Africa’s stringent lockdown measures have decimated the fiscus and the largest deficits in history are looming. Thus far, this reality hasn’t materialised in either the bond market or the currency because:
- Many other emerging markets face exactly the same problem, so on a relative basis not much has changed.
- The SARB acted rapidly and firmly, not only reducing rates drastically, but physically intervening in the bond market.
- SA received large loans from global funding institutions, at favourable rates, alleviating short-term funding pressures.
Herman said that finance minister, Tito Mboweni has to take to the stage during October with the MTBPS which is the traditional policy-setting framework, rather than a detailed budget.
“We know that government has indicated that it aims to rebuild and transform the economy all 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 won’t be able to avoid the harsh realities of a record budget deficit and worsening credit profile.”
“The IMF loan adds a new dimension to our credit dynamics, as it is short term in nature, dollar denominated and being spent on running expenses around the pandemic. This capital isn’t invested in any expansion of economic capacity, but purely splashed over the economy as short-term pain relief. Yet it has to be repaid, in dollars, from the normal budget, starting in 3 years’ time.
“This is a new crocodile in Mr Mboweni’s pool,” said Herman.
He said that the government’s inability to refuse funding to floundering state-owned enterprises keeps a very hefty ball-and-chain around the fiscus’ ankle. It highlights the political inability to implement the structural reforms promised for so long and still nowhere to be seen. “Global creditors are taking note,” he said.
In the near term, US election debates will continue to take up the focus of investors, as they will have implications for the November ballot.
“With short-term dollar weakness still on the horizon, the original R16.50/$ 2020 year-end forecast seems reasonable,” said Herman.
He said that 2021 promises to be a global recovery year, so a benign growth and commodity environment should support the rand in general.
Phases of global risk-on sentiment will support the rand and a test of sub-16.00 is highly likely.
“If, however, the rand is considered fair value around R16.50 by the end of 2020, it makes it difficult to see a meaningful and sustained rally beyond R15.50 during the year.”
He said that the probability of sub-R16.00 by end of 2021 is 10%.
Interest rate parity is like gravity in forex markets, so the rand faces at least 75c of weakening due to this factor alone, placing the equivalent fair value for end 2021 around R17.25, said Herman.
He said that the probability of the rand between R16.50 and R18.00 at the end of 2021 is 50%.
“The poor credit metrics are bound to materialise eventually,” he continued. 2021 might still be early, but the first IMF loan repayment is approaching fast.
“With SA’s weak growth dynamics, a comfortable growth-led resolution to the debt metrics is highly unlikely, if not near impossible,” he said.
Herman said that the probability of the rand weaker than R18.00 by end of 2021 is at 40%.
BNP Paribas meanwhile, said that the rand is likely to end the year at R16.50 against the dollar. “Expect South Africa to lag its EM peers in terms of the peace of economic recovery, but its balance of payments has recently turned supportive for the ZAR, with adjustments to its trade balance, slowdown in portfolio outflows, and lower deficit on the primary income side.
“Improving terms of trade, in our view, will have a protracted, positive impact on the currency,” it 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 2.2m jobs lost in Q2. Our estimates are for +- 1.2m jobs lost at year end. Private sector credit slowed to 3.9% from 5.1% in August.
— Wayne McCurrie (@WayneMcCurrie) September 30, 2020
Goldman Sachs has maintained a bullish stance for the rand, calling it ‘deeply undervalued’.
Goldman forecasts a further prolonged recovery for the local unit in the final quarter, all the way down to R15.80 by year-end, according to PoundSterlinglive.
“Both the rand and ruble appear to feature more room to run, with the ZAR standing out as deeply undervalued on standard metrics,” said Kamakshya Trivedi, chief emerging markets macro strategist at Goldman Sachs.
“Given significant domestic risks, however, including South Africa’s October mid-term 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 currency is whether high global betas can (eventually) trump domestic headwinds.
“On this front, we are optimists; with Chinese data – to which ZAR is sensitive – suggesting a continued recovery.”