South African Rand Forecast to Underperform as More SARB Cuts Loom

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- GBP/ZAR spot at the time of writing: 22.94
- Bank transfer rates (indicative): 22.15-22.31
- FX specialist rates (indicative): 22.61-22.75 >> More information

The Rand's recent recovery unwound further on Tuesday after the South African Reserve Bank (SARB) surprised the market with a large cut to the cash rate to counter the effect of a national coronavirus 'lockdown' that risks seeing the currency continue to underperform emerging world rivals this year. 

South African policymakers voted for a 100 basis point cut to the cash rate, from 5.25% to 4.25%, in a surprise decision this week that will radically reduce the Rand's yield offering to investors and its likely appeal relative to other currencies. The Rand fell more than 1% against the Pound, Dollar and Euro after the announcement, confirming an end to week long rally that lifted off a record low against the Dollar and multi-year lows relative to Sterling. 

"While we think action today pre-empts most of the negative developments anticipated by the SARB, we think that another 50bps of easing may be in the card for July. The ZAR is likely to underperform EM FX peers this year," says Cristian Maggio, head of emerging market strategy at TD Securities. 

The Reserve Bank announced the decision via its Twitter account, citing the growing coronavirus outbreak in the country and the likely economic impact of a government decision to extend a national 'lockdown' by an additional 14 days, taking the total economic stoppage to 35 days. It says this and other factors will produce a significant -6.1% economic contraction for 2020 and have already driven more more than R100 billion of foreign capital out of the country, partly explaining 2020's 30% increase in USD/ZAR.

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

Tuesday's rate cut was a surprise for the market and will almost certainly explain the knee-jerk move lower in the Rand, although the South African currency may now have to price-in an even greater level of interest rate cuts for the months ahead given the SARB's quarterly projection model is recommending a total of five more 25 basis point interest rate cuts before the first quarter of 2021. 

"While we understand that all global governments are on a spending spree due to coronavirus, and central banks are playing their part in supporting growth and deficit financing through QE programs, the market will not remain totally indifferent to same actions taken in South Africa or other weak EM," Maggio warns. "ZAR will remain the shock absorber that could continue to suffer the consequences of a dire economic outlook, met with extraordinary easing." 

Maggio says "it's difficult to forecast a USD/ZAR level at this point" but that South Africa's Rand is likely to remain one of the worst performing emerging market currencies this year. The South African economy was already facing the prospect of three quarters in recession even before the coronavirus put a stop on the world economy while the Rand is still set to face a reckoning at month-end with the April rebalancing of the FTSE World Government Bond Index. 

Exclusion from the index results from the Moody's downgrade of South Africa's credit rating into 'junk' territory and is widely expected to force the sale of South African government bond holdings by many investors but including those from overseas, potentially leading to large outflows from the Rand. And given the likely worsening coronavirus situtation at the time, it cannot be ruled out that those outflows pick up and put pressure on the Rand ahead of month-end. 

Above: USD/ZAR rate shown at weekly intervals, with Fibonacci retracements of January 2016 downtrend marked out.

This month's Rand losses have taken the USD/ZAR rate up and above the 100% Fibonacci retracement of the downtrend that dates back to January 2016 and enabled it to mark a new record high in the process. But since breaking above that retracement level the exchange rate had found support upon it twice before Tuesday, suggesting the currency might need to gather meaningful momentum before it's able to push back below it.

"The humanitarian loss is aggravated by the economic loss, though some might argue the reverse also holds true," says Nema Ramkhelawan-Bhana, an economist at Rand Merchant Bank. "Analysts are now forecasting a 35% contraction in advanced economies’ GDP output this quarter, which exceeds the losses ensured during the GFC by four-fold. That reality extends to EM economies, some of which are in a far worse position to contend with the fallout given limited policy space and a lack of healthcare resources."

The National Institute of Communicable Disease said Monday it was aware of 2,272 coronavirus infections in the country, with 27 deaths, as the global total approached 2 million. South Africa detected the first coronavirus case on March 06 and since then there's been rapid growth in the number of infections, prompting the government to place citizens and the economy into 'lockdown'.

Resulting weakness in the South African currency has lifted the Pound-to-Rand rate 24% for 2020 and brought it into contact with the 78.6% Fibonacci retracement of the  downtrend established in January 2016. That was offering effective resistance up until Tuesday but a weekly close above it might set the scene for a new record high to be reached over subsequent weeks or months.

Above: Pound-to-Rand rate shown at weekly intervals, with Fibonacci retracements of January 2016 downtrend marked out.

"After this crisis the debt burden of many low-income countries, in particular, will be unsustainably high. Multi-lateral and bilateral debt relief for these countries will be one of the medium term steps required for a longer term economic recovery. In particular in a world of low growth in developed markets, it would make even more global sense to unburden lower income countries," says David Hauner, head of emerging market strategy at BofA Global Research.

South Africa's effort to contain the coronavirus is made more difficult by a stretched fiscal position that had already prompted a downgrade of the country's credit rating from 'investment grade' to 'junk' by Moody's, the last agency to rate it a top quality borrower. That stretched fiscal position could constrain the government in its ability to support South African households and companies in the same way as many developed world governments have.

There are now increasingly loud calls in the press as well as financial world for emerging markets to be granted debt relief by creditors that would enable their governments to spend what's needed in order to backstop their economies. 

"If one listens to the cry for help which the BIS made recently, the Fed is soon going to be called on to offer trillions more USD right along the global Eurodollar pathway," says Michael Every, a strategist at Rabobank. "Is there going to be a bailout for all USD junk, or just US USD junk?"