The rand lost ground against the dollar in trade on Wednesday (15 April), after finance minister Tito Mboweni warned of a likely ‘deep recession’ in 2020 caused by the Covid-19 pandemic, and resultant 35-day lockdown period in South Africa.
“Going into this health care crisis, the economy was already in recession. Without doubt, given what we know since February, Covid-19 will certainly further deepen the South African downturn woes,” said minister Mboweni.
“At this stage, our central scenario is for a deep recession in 2020, followed by a rapid upswing in economic growth. Critically, the path relies on an understanding of how the global economy will adjust,” he said.
The rand weakened against the major basket of currencies, losing more than 3% against the dollar, while the All Share Index fell 3.3% in mid-morning trade.
- Dollar/Rand: R18.64 (2.31%)
- Pound/Rand: R23.33 (1.20%)
- Euro/Rand: R20.38 (1.74%)
The South African Reserve Bank meanwhile decided to cut the repo rate by 100 basis points in a surprise move on Tuesday (14 April), to 4.25% per annum, representing a third cut in 2020 thus far.
However, the Reserve Bank said it expects GDP in 2020 to contract by 6.1%, compared to the -0.2% it forecast just three weeks ago. GDP is expected to grow by 2.2% in 2021 and by 2.7% in 2022, the bank said.
The rate cut prioritises economic growth, said Mokgatla Madisha, head of Fixed Interest at Sanlam Investments, who added that the relative stability in the markets after the Moody’s downgrade gave the Monetary Policy Committee confidence to bring forward the May rate decision.
How did the market react?
Once the rate cut decision was announced the rand sold off 35 cents against the dollar, said Madisha.
“The decision came just before the weekly bond auction. There was a somewhat delayed reaction in the bonds but in the end the 3-year bond rallied about 71bps on the day, while the benchmark R186 (6-year bond) rallied only about 51bps and the R2048 bond, maturity 2028, rallied 25bps from its close on Thursday, 9 April.
“Bond yields had been trading about 10bps up prior to the announcement.”
Where to from here for interest rates?
Madisha said that given the scale of the output contraction expected this year, “we think the repo rate could eventually be cut to 3%”.
“Inflation and rand trajectory will be key in determining whether the SARB will cut enough to reach that level. At this stage we can say that returns from cash will not be appealing over the next 12 months.”
All eyes are now on government’s fiscal policy
For bonds longer than three years, fiscal policy is much more important than interest rate decisions, said Madisha.
In February, National Treasury was forecasting a deficit of 6.8% for 2020/21. “As a result of the 21-day lockdown we were of the view that the deficit will reach 10% of GDP, which would result in a funding requirement of close to R590 billion compared to R407 billion in the 2019/20 fiscal year.
Standard Bank projects that the extra two weeks of lockdown and resulting economic contraction could push the funding requirement to R740 billion.
“We do not share the SARB or National Treasury’s view that such large deficits can easily be financed in the domestic market,” the market analyst said.
South Africa’s yield is curve is one of the steepest amongst emerging markets and Tuesday’s action by the SARB and government’s fiscal policy will ensure that the curve stays steep, said Sanlam Investments.
“We are overweight in the 10- to 12-year sector of the curve and we will maintain this position. Funding at real rates far higher than the economic growth rate will lead to a debt/GDP ratio that does not stabilise,” said Madisha.
Nedbank meanwhile on Tuesday withdrew guidance for its key financial numbers for 2020, citing the rapid escalation of the Covid-19 pandemic and the Moody’s and Fitch downgrades, which have placed unprecedented challenges on the South African economy.
“It is difficult to accurately predict the progression and duration of the Covid-19 pandemic globally and in South Africa, our predominant market, as well as the residual risks when the lockdowns are lifted.
“As a result, it is not possible, at this stage, to accurately predict the economic outcomes of the virus and the impact these will have on the banking outlook,” the bank said.
Nedbank said that its withdrawal of guidance for 2020 is in line with similar announcements made recently by many companies on the JSE.