South African Rand Forecast to Languish Near Historic Lows for Months amid SA Lockdown

-ZAR forecasts downgraded at Commerzbank amid SA lockdown. 

-USD/ZAR to remain near 17 for months, GBP/ZAR to hold 20.00.

-Moody's, lockdown, SARB cuts and recession to weigh heavily.

-But charts suggest USD/ZAR top is in, consolidation now likely.

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- GBP/ZAR Spot Rate: 20.59 +0.09% on publication

- Indicative bank rates for transfers: 19.87-20.02

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The Rand will languish near record lows until at least mid-year, according to downgraded forecasts from Commerzbank, as South Africans grapple with a coronavirus-induced 'lockdown', credit rating concerns and a recession that are tipped to draw further rate cuts from the South African Reserve Bank (SARB).

South Africa's Rand fell to a new record low against the Dollar this week and remained on the defensive against Sterling after President Cyril Rampahosa announced a national 'lockdown' following a sharp rise in the national number of coronavirus cases from zero to 402 in barely more than a week. That number had risen to 554 by Tuesday, according to the National Institute of Communicable Disease, and is expected to rise further throughout the 21 day 'lockdown' that comes into force at midnight Thursday.

Most businesses will close and citizens will be confined to their homes from Thursday as members of the National Defence Force patrol the streets in support of police efforts to enforce the nationwide quarantine. This will bring South Africa's economy, which was already in recession before the viral pneumonia ever left China, to a standstill and necessitate increased spending from the government just days out from a Moody's credit rating review that could see the national rating downgraded to 'junk'.

"The global Covid-19 spread and generally rising risk aversion has taken its toll on the ZAR," says Elisabeth Andreae, an analyst at Commerzbank. "The government has declared the state of national disaster, and the central bank has cut rates drastically. We have adjusted our forecasts downwards."

Above: Pound-to-Rand rate shown at daily intervals alongside USD/ZAR (black line).

South Africa already had a full plate before the coronavirus landed given the economy fell into recession in the final quarter and was expected to contract this quarter even before coronavirus became a problem. The government has been under pressure to cut spending and lift tax revenue in order to reduce the budget deficit and get a grip on a rising debt-to-GDP ratio, else face a potentially currency-crushing downgrade to 'junk' by Moody's.

But now a virus hit economy could automatically lift the debt-to-GDP ratio even before the government gets to covering the costs of a 21-day economic shutdown. Moody's will announce its latest rating decision after the market close Friday and if it has opted for a downgrade, South Africa's troubles could grow larger overnight given such a decision will force the sale of government bonds by international investors who've already been getting flighty. 

"Government finances are already stretched to such an extent that without consolidation, the country is in danger of over-indebtedness in the long term - and in the short term a rating downgrade by Moody's is looming," Andreae says. "In view of the uncertainty about the further national and global course of the pandemic, the resulting recessionary economic trends and possible further interest rate cuts, the rand faces further hard times."

Andreae and the Commerzbank team had tipped the USD/ZAR rate to end the March quarter at 16.80 and the Pound-to-Rand rate to close the month at 22.52, before correcting lower over the balance of the year. However, the Rand has overshot the USD/ZAR projection and the anticipated move lower is now expected to be shallower in light of the coronavirus challenge. 

Commerzbank now forecasts the Rand will remain near to 17.0 against the Dollar at the end of June and that it will only recover as far as 16 before year-end. These are quarter-end landmarks, however, so they don't preclude interim overshoots and undershoots of the target levels

Above: USD/ZAR rate at weekly intervals, setting new record high after breaking above 61.8% and 78.6% retracements.

"USD/ZAR continues to surge higher and has so far risen to its current new all-time high at 17.8953, to marginally above the previous all-time high at 17.8902, made in January 2016," says Axel Rudolph, a technical analyst and Commerzbank colleague of Andreae's. "While remaining around the 17.9000 area and below the next higher 18.0000 mark we expect to see a slide back to the March 9 high at 16.9932 unfold."

South Africa's Rand broke above the 78.6% Fibonacci retracement of the January 2016 downtrend last week before surging above the 100% retracement and setting a new all-time high for the USD/ZAR rate in the process on Monday. 

Meanwhile, the Pound-to-Rand rate has failed to sustain a break above the 50% retracement of its own January 2016 downtrend although with the Dollar increasingly tipped to cede ground to many major currencies, the British unit could yet break above the 20.62 level. It's forecast to remain comfortably above the 20.0 level until mid-year, before rising to 20.48 in time for year-end. 

The Pound-to-Rand rate is effectively the sum of GBP/USD over ZAR/USD so if the Rand remains on the defensive against the Dollar and the Dollar itself cedes ground to Sterling, the Pound-to-Rand rate would rise. Commerzbank forecasts the GBP/USD rate will rise to 1.18 by the end of June and 1.28 by year-end. 

"With its exceptionally large step, the SARB is signaling that it is prepared to make its contribution to stabilizing the economy in the face of the corona crisis. We have adjusted our forecast and so far expect a further interest rate cut in 2020. Depending on the course of the Covid epidemic - globally and for South Africa - further steps cannot be ruled out," Andreae warns.  

Above: Pound-to-Rand rate at weekly intervals, repelled by 50% retracement of 2016 trend but nestled above 20.0.

The SARB surprised investors last week by cutting its cash rate 100 basis points to 5.25% when consensus had expected only a 50 basis point cut. It cited the threat posed by the coronavirus and efforts to contain it, although the rub for the SARB and Rand is that this cut might not make it as far as the wallets of households and businesses due to events in the bond market. 

South African bond yields, which move in the opposite direction to prices, have been surging for weeks now and have continued to rise even after the 100 basis point rate cut. That's unusual because yields, which represent the interest return earned by investors who buy bonds in the secondary market, typically fall alongside currencies in response to interest rate cuts. And it's a problem because some bond yields get baked into just about every interest rate that's charged across an economy, whch means that South African borrowing costs might rise soon even though the SARB has cut the cash rate sharply. 

The government's 10-year bond yields had risen to their highest level since 1996 by Tuesday and the 3-year yield had risen back to levels that prevailed when the South African cash rate was 6.5%.

"I remember having discussions in the dealing room of how high the yields on the benchmark bond could go on the back of a Moody’s downgrade, and a lot of people mentioned 200bp would be a lot. We’ve done more than that in the space of three weeks, and Moody’s review hasn’t even happened yet," says Michelle Wohlberg, a bond salesperson at Rand Merchant Bank. "With Moody’s review and the GBI EM rebalancing set for the end of this month, I do think investors will still approach SAGBs with caution, but as yields continue to tick higher, they become more compelling with every passing day."

Above: USD/ZAR at daily intervals, alongside 3-year (black) and 10-year (orange) SA yields. All rise after SARB rate cut.

Yields have surged just about everywhere in recent weeks but including where there have been rate cuts and on each of the latter occasions yields have elicited a further and greater response from the central bank in question. The best examples are the Federal Reserve (Fed) and Bank of England (BoE).

The Fed and BoE saw yields rise sharply after earlier rate cuts, as investors moved from bonds into cash, prompting both to cut rates to the 'zero lower bound' and increase their quantitative easing (QE) programs. QE involves a central bank buying government bonds, forcing down yields and and reducing real economy borrowing costs in the process. The Fed now says it intends to buy an unlimited supply of U.S. government bonds while the BoE has lifted its bond purchase intention by £210bn, from £435bn to £645bn when a small allocation for corporate bonds is included. 

However, and if recent market conditions have been sufficient to force two of the world's largest central banks to extremes, there might be some chance the SARB is also compelled to go even further too. And that could spell another headache for the Rand. Some might argue there is a case for greater action from the SARB given the government is constrained by credit rating concerns and limited in its ability to provide fiscal stimulus for the economy.