South African Rand Seen Drawing Support from Fed Retreat in March but Moody's May Gatecrash the Party Soon After

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- ZAR clings to gains as global environment supports, ratings fears ease.

- March could see ZAR extend rally against USD and GBP says Investec.

- But month-end may see Moody's gatecrash the party, sending ZAR lower.

The Rand has risen more than 1% against the U.S. Dollar and other major currencies in the last week and could go on to enjoy a solid bid from the market throughout the coming month, according to economists at Investec Bank, although Moody's could soon gatecrash the party in South Africa.

South Africa's Rand has continued to retake ground lost to the Dollar earlier in February as markets have become less concerned about the immediate outlook for the nation's credit rating, and given events elsewhere in the world are proving supportive of so-called risk assets like the Rand. 

President Donald Trump has said U.S. tariffs on Chinese exports to America will not rise to 25% on March 01 as they had been expected to, given negotiators are making progress in talks to end the trade war between the world's two largest economies. 

That has removed a significant and imminent risk to the global economic outlook while the recent decision by the Federal Reserve (Fed) to be more "patient" before raising its interest rate again has installed a previously-absent floor beneath emerging market assets like the Rand. 

"With the domestic currency reaching R13.85/USD, R15.72/EUR and R18.12/GBP today, it is approaching levels pre Budget 2019  jitters, with possibly some room for further strength in the near term on supportive global factors," says Annabel Bishop, chief economist at Investec. "However, at the end of March it risks weakness as a Moody’s credit rating downgrade could occur, instead of merely a drop in the outlook."

Above: Pound-to-Rand rate shown at daily intervals.

Federal Reserve Chairman Jerome Powell will appear before the Senate Banking Committee Tuesday to deliver a semiannual monetary policy report to Congress. He could provide further clarity on the extent to which the Fed is uneasy about the domestic and global economies. 

Any commentary from Powell that speaks to market hopes of an extended pause in the Federal Reserve rate hiking cycle could drive the U.S. Dollar lower and the Rand higher during the coming weeks. But that could be about the extent of the Rand's gains. 

"Moody’s has requested more information on Eskom, and as such will digest this before it delivers its verdict on SA’s sovereign debt long-term dual currency (local and domestic) credit rating. It is scheduled to release its country review on SA’s credit rating on 29^th March," Bishop says. 

This weeks price action follows the latest government budget plan, which painted a picture of stretched public finances, the bounds of which will be tested even further during the months ahead by increased financial support to troubled power utility Eskom. 

New loans for Eskom will put the government out of pocket to a tune of R6 bn each year because the full R23 bn allocated to company cannot be recouped by cuts to spending elsewhere. 

The government is on the hook for R350 bn (£21 bn) of Eskom's debt pile, which is equivalent to around 8.5% of national GDP, and Moody's is worried about the power utility's solvency in the absence of further public support. 

Eskom's demands on the public purse risk making an already-bad situation even worse. Public spending and borrowing is set to rise further than was previously thought over the coming years, but the government still says its deficit will return to 4% of GDP by the end of 2022. 

"The 2019 Budget was seen as credit negative by Moody’s, but as expenditure exceeds MTBPS projections only in one year it may be enough to stave off an actual credit rating downgrade for the year – we continue to forecast a change in the outlook to negative from stable, signalling a rating downgrade with eighteen months thereafter," Bishop warns. 

Above: USD/ZAR rate shown at daily intervals.

Moody's gave South Africa a reprieve in March 2018 when it left the nation's credit ratings intact at Baa3, which is just about inside the "investment grade" threshold and only one notch above "junk status".

It upgraded the outlook from negative to stable at the same time but there's since been speculation that the March 29 review will see it switch that outlook back to negative, implying a downgrade to "junk" could happen in the next 18 months.

Almost half of South Africa's government bonds are owned by foreigners who have invested in a "global bond fund" and many of those funds benchmark themselves against the Citi WGBI local currency bond index. In other words they attempt to mimic its performance. 

But the Citi WGBI only includes selected countries and all of those have so-called investment grade ratings. South Africa might be excluded from the benchmark if it is downgraded to "junk", which could then force relevant money managers into selling their bonds. 

That would almost certainly mean lots of Rand being dumped on the market by investors seeking buy back their domestic currencies, leading to downward pressure on South Africa's exchange rate. Total South African government debt is equal to more than 50% of the nation's GDP.

Investec's Bishop says global factors like Federal Reserve policy and the trade war truce between the world's two largest economies could drive the USD/ZAR rate down to 13.40 before the end of March, and the Pound-to-Rand rate to 17.39. 

However, after March the Rand is forecast to depreciate again over the subsequent two quarters, taking the USD/ZAR rate to 14.10 before the end of September and the Pound-to-Rand rate back up to 19.47.

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