South African Rand Sweeps Higher as Bond Index Exclusion Looms

- ZAR advances on USD, GBP and EM rivals in risk-on trade.

- As investors cheer widespread moves to ease virus lockdowns.

- And as oil prices slide back toward zero, bolstering ZAR rally.

- But bond index exclusion looms, risks fresh losses on Thursday.

Image © Government of South Africa, reproduced under CC licensing

- GBP/ZAR spot rate at time of publication: 23.25
- Bank transfer rates (indicative): 22.45-22.61
- FX specialist rates (indicative): 22.92-23.05 >> More information

The Rand swept higher against the Pound, Dollar and most emerging market currencies Tuesday just days ahead of South Africa's exclusion from the FTSE World Government Bond Index, an event that could curtail the recovery if-not send the Rand back toward recent historic lows. 

South Africa's Rand almost swept the board of opposition Tuesday as investors rewarded the easing of 'lockdown' restrictions with a firm bid for risk assets, helping the Rand to overcome all major currencies other than the Norwegian Krone. It also rose against all other emerging market currencies except the Mexican Peso and Indian Rupee, Pound Sterling Live data shows. 

"We are cautious as these economies are all still very much in lockdown, and it could take months to reach full economic activity, while the risk of a second wave of the virus remains a real threat. The rand continues to seesaw between R18.80 and R19.20/$, with further short-term downside on the table as we approach the rebalance of the World Government Bond Index (WGBI) at month end," says Bianca Botes, an executive director at Peregrine Treasury Solutions. 

Above: South African Rand performance against major currencies. Source: Pound Sterling Live.

Countries in Europe, the antipodes and North America are increasingly setting out plans to ease restrictions on daily life while South Africa set out its own late last week, lifting the Rand into the weekend. Prime Minister Boris Johnson returned to office Monday after his own battle with the virus and is expected to follow suit by setting out a blueprint for a phased reopening of the UK economy.

Cratering oil prices may also have bolstered the Rand's attractiveness to international money given that South Africa is heavily reliant on energy imports, which offers a consolation to the battered and bruised economy, albeit only a small one. Some analysts say oil prices could be heading back toward zero as supply remains plenty, demand has evapourated and as the U.S. Oil Fund seeks to 'roll' its exposure to June oil futures contracts out into subsequent months. 

"Broad USD gauges continue to get shellacked. This time gains are led by the Scandies (SEK, NOK) as well as the ZAR," says Bipan Rai, North American head of FX strategy at CIBC Capital Markets. "Commodities under a bit of pressure with prompt WTI continuing to trade defensively. That’s a bit at odds with moves in FX markets – though we suspect the latter is moving in-line with timelines to re-open economies rather than with traditional correlations." 

Above: USD/ZAR rate shown at daily intervals alongside WTI crude oil price.

Rolling of the U.S. Oil position begun on April 27 when initially it wasn't scheduled to start until June 01 and will involve selling June oil futures contracts in transactions that might amplify the downside for prices, potentially offering the Rand further support. But this will be small beer compared with the challenges facing South Africa's already-in-recession economy and it might not be enough to counter the outflows that could be prompted by Thursday's exclusion from the FTSE World Government Bond Index.

South Africa is set to drop out of the bond index on Thursday after Moody's cut the government's local currency credit rating from 'investment grade' to 'junk' back in March, which will see fund managers who benchmark to it prevented from holding the government's bonds in their portfolios. This will compel the sale of any bonds that have not yet been removed from portfolios and could lead to capital outflows as well as pressure on the Rand.

"The rand has lost much more than most comparable emerging market currencies, having already shed 34.5% year-to-date; our currency will remain under pressure for some time due to both SA’s exclusion from the WGBI as well as the ongoing pandemic. Nonetheless, the rand remains significantly undervalued and should, therefore, ultimately recover," says Thanda Sithole, an economist at Standard Bank, who says outflows from South Africa have already reached 2% of GDP. USD/ZAR was up 33.25% for 2020 on Tuesday.

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

A cruel twist of fate means Thursday's bond index exclusion will mar the first day that South Africa partially eases its own coronavirus 'lockdown.' This is also April 30 and the point at which the country moves to a "a risk adjusted strategy" and five-stage traffic light system where level 5 restrictions represent the most drastic form of economic lockdown and level 1 denotes a system in which only basic social distancing measures need be deployed.

"A lifting of restrictions is not a panacea for growth or prosperity as Moody’s continues to remind us, lowering its outlook on the banking system to negative, stating that the R500bn stimulus package would do little to negate the expected rise in problem loans, which the agency believes will exceed GFC levels. Not a particularly comforting thought as we journey through the various stages of the national alert system," says Nema Ramkhelawan-Bhana, an economist Rand Merchant Bank. "A follower rather than a leader this week, the local unit will track the broader EM complex, which is up 3.3% this morning according to the MSCI measure, supporting USD/ZAR below the 19.00 threshold." 

South Africa first detected the coronavirus on March 06 and went into 'lockdown' on March 27, at which point the virus began to lose momentum in Africa's largest economy although it is still advancing, logarithmic scaled graphs plotting daily case numbers show. This is after April 23, the day on which plans to ease the lockdown were announced, brought the largest number of new coronavirus infections for a single day with 318 new cases lifting the total to 3,953. There were 247 new cases on April 27.

Nonetheless, last Thursday's decision to begin lifting the lockdown has not only turned the USD/ZAR rate away from the historic lows set earlier in April but has also succesfully prevented the Pound-to-Rand rate from breaking above the 78.6% Fibonacci retracement of the January 2016 downtrend at 23.57. That level has now road-blocked the Pound-Rand rate for four consecutive weeks and counting, although whether it continues to hold might depend on the damage done by the bond index exclusion.

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