Rand Wounded in Chinese Currency Sell-off as Analysts Warn of More Losses Ahead

Image © Government of South Africa

- ZAR hit by sell-off in Chinese currency as trade war escalates.

- Vulnerable ZAR has strongest correlation with CNH says ING. 

- J.P. Morgan technical strategist eyes key level and more losses.

- TD Securities warns on Moody's rating and ZAR losses ahead.

The Rand slumped at the opening of the new week Monday as many emerging market and commodity currencies were dragged into the red by a falling Chinese Renminbi, but there is still plenty of scope for losses to build further, according to mutliple analysts. 

The People's Bank of China (PBOC) set its USD/CNY 'fixing' rate at 6.9220 Monday when the market had been looking for the bank to set the exchange rate below 6.90 in an effort to shore up investor confidence in the its ability to keep the currency stable, prompting a sell-off in Renminbi exchange rates and other correlated currencies. 

Chinese central bankers say Monday's fixing was dicated by a financial model that's simply recognising changes in economic fundamantals but it was seen by many analysts as an indication the PBOC intends to allow the Renmimbi to weaken in response to President Donald Trump's latest tariffs.

China-related developments are significant to the Rand because the world's second's economy is the South Africa's largest export market and a significant foreign investor, which has helped develop a correlation between the Rand and Renminbi. As an emerging market country South Africa is also perceived as being a more risky investment destination, which means the Rand also tends to suffer when risk appetites among international investors are waning. 

"This is all bearish for risk assets and cyclical currencies. Expect the safe havens of JPY and CHF to remain in demand (especially with very limited room for FX intervention), while commodity FX and EMFX in general should stay under pressure – the ZAR and IDR have had the highest correlation with CNY this year," says Chris Turner, head of FX strategy at ING. 

Monday's fall in the Renminbe was taken by the market as a sign the PBOC intends to use the exchange rate as a weapon against the White House, which said last week that 10% tariff will be imposed on China's remaining $300 bn of annual goods exports to the U.S. from September 01 in an apparent effort to pressure Chinese leaders into agreeing a deal addressing China's "unfair" trading practices that they backed out of earlier this year. 

Above: USD/ZAR rate at hourly intervals, alongside USD/CNH rate (yellow line, left axis). 

Financial markets had hoped the ceasefire agreed during the G20 summit at the end of June would last, enabling the global economy to recover from a slowdown induced by elevated uncertainty over the growth outlook as well as steep falls in business confidence and investment that have resulted from the tariff fight. But Monday's sell-off suggests investors are now preparing for a more protracted period of confrontation between the world's two largest economies, which is negative for the Rand. 

"Our our main focus is now on key-resistance between 14.7932/14.8457 (daily breakout line/int. 76.4 %) and 15.1138/15.1642 (76.4 % on higher scale/2019 high). Below, the risk of running into a deeper setback remains high, whereas a break above 15.1642 would bring 16.3843 (76.4 % on highest scale) into focus," says Thomas Anthonj, a strategist at J.P. Morgan. 

The USD/ZAR rate was quoted 1.1% higher at 14.92 Monday while the Pound-to-Rand rate was 1.13% higher at 18.16 despite a tepid performance from the British unit against other major currencies. But J.P. Morgan's Anthonj says there's a risk the USD/ZAR pair could soon return to highs not seen since the end of 2017 when fears over South Africa's financial future were at their peak amid uncertainty over the African National Congress (ANC) leadership election that produced President Cyril Ramaphosa.  

Anothonj's reasons for doubting Rand are technical in nature and so based on studies of trends and momentum on the charts rather than economic or financial fundamentals. But TD Securities, a Canada-headquartered global investment bank, said Monday there are such fundamental reasons for being concerned about the outlook for the Rand. 

Above: USD/ZAR rate shown at weekly intervals. Captures 2017 losses for Rand.

Cristian Maggio, TD's head of emerging market strategy, says risks to South Africa's top credit rating could hurt the Rand later this year. 

"Fiscal deterioration and the risk of downgrades are behind recent adverse ZAR performance that has turned the rand into the second worst performing EM currency in the past week," Maggio warns. "There is a material chance, however, that the recently announced bailout of Eskom will drag South Africa's sovereign ratings lower, especially on account of a downgrade to junk by Moody's that looks increasingly."

Moody's, the last remaining major agency to still rate South African debt as 'investment grade', warned lasy week that the Eskom support package announced by finance minister Tito Mboweni is "credit negative" because it'll put the country further away from attaining its objectives of a lower budget deficit and lesser national debt pile. The government sought approval last week for a R59bn of cash injections into Eskom over the next two years, which comes on top of R46bn already approved for the period.

This is adding to the budget deficit and debt-to-gdp ratio at a time when ratings agencies want to see both falling. Losing the Moody's 'investment grade' rating could hurt the Rand because it would force some institutional fund investors to sell their South African government bonds, leading to lots of Rand being dumped on the market. 

And for every notch below 'investment grade' the rating falls, the more the pool of international funds able to own South African bonds will shrink, which means increasing downward pressure on the Rand. Moody's is due to announce its next rating decision in November. 

"The correction we have observed in USDZAR since 25 July, has moved the rand from being overvalued vs our forecasts, to being undervalued at the moment. We continue to expect the pair to end this quarter at 13.95 and lower at 13.85 by year-end. This is, however, mostly predicated on the expectation that the government of South Africa will soon take serious responsibility for delivering the structural reforms needed to turn around Eskom," Maggio says.

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