South African Rand Turned Away from Post-March Highs as Local Stocks Seen as Key to Outlook

-ZAR turned back from post-March high after SARB crushes yields.
-Risk appetite sours on China, fiscal support, U.S. economy concerns.
-SARB rate cut comes as SA closes schools until coronavirus peaks.
-Local firms see ZAR in range to year-end as RBC eyes local stocks.

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The Rand remained in retreat from post-March highs Friday after being turned away from them when a South African Reserve Bank (SARB) interest rate cut crushed local bond yields, and some analysts say the domestic stock markets will be key to the outlook from here.

Risk appetite has soured with as confidence was undermined by hostilities between the world’s two largest economies, concerns about the U.S. outlook and the seemingly ebbing prospect of American lawmakers acting in time to prevent a rug of fiscal support being pulled from under households' feet.

Losses for stock markets and other risk assets have had a mixed impact on the U.S. Dollar, which has risen with early European trade in the latter half of the week only for aappetie to ebb as the North Amerian open approaches, although South Africa’s own domestic troubles have ensured that the Rand remains on the back foot even as some Dollar pairs weaken.

"The Chinese retaliation on Friday morning, ordering the US to shut its consulate in Chengdu, further increased market jitters causing the rand to lose ground during early trade. The tension between the two powerhouse economies calls global trade relations into question at a time when countries are in dire straits due to the COVID-19 pandemic," says Bianca Botes, an executive director at Peregrine Treasury Solutions. 

Above: South African Rand performance against major developed and emerging market rivals. Source: Pound Sterling Live.

Rand losses picked up when a tit-for-tat exchange of consulate closures between the U.S. and China conspired with a South African Reserve Bank interest rate cut to turn the local currency back from its highest levels against the Dollar and Brexit stricken Pound since March.

South Africa’s central bank cut the cash rate by 25 basis points to 3.5% in line with market expectations in the Thursday session, although in spite of a consensus that had widely flagged the move, the 10-year bond yield fell back toward early June lows and took the Rand with it.

“The MPC cut its projections for growth lower and adjusted some of the inflation forecasts to the downside as we had expected. But the revisions weren't enough to trigger a bolder move by the MPC. As the MPC is in wait-and-see mode now, further cuts are not a foregone conclusion in the near future. We pencil in a final 25bps cut for September but stand ready to adjust our forecast to new data available and to reflect a more hawkish MPC,” says Cristian Maggio, head of emerging market strategy at TD Securities, who’d looked for a cut to 3.25%.

Above: USD/ZAR rate shown at 4-hour intervals alongside Pound-to-Rand rate (orange line).

SARB Governor Lesetja Kganyago said on Thursday that South Africa’s economy is likely to contract by -7.3% in 2020, a downgrade from earlier the projection of -7%, although he also said that risks to the inflation outlook are now balanced. This indicates the bank is at least close to considering itself done with rate cuts that have taken the cash rate down from 6.25% in 2020.

The cash rate is -275 basis points this year but the SARB’s quarterly projection model still advocated Thursday another -25 point cut by year-end.

"Lockdown measures have eased substantially and the global economy is in the process of a patchy recovery, with markedly more positive data," says Lara Hodes, an economist at Investec. "Global economic activity is likely to exceed SA’s economic recovery in both speed and pace. Many structural weaknesses remain domestically, while the ongoing weak ability of SA to meet the electricity needs of an economy growing at over 1.0% y/y will be a key limitation."

Above: USD/ZAR rate shown at daily intervals alongside Pound-to-Rand rate (orange line).
Even with steep 2020 rate cuts, intended to provide a crutch for businesses, households and government to lean on, South African government bond yields have remained among the highest in the world.

Meanwhile, falling inflation expectations have helped spare the Rand from the same pressure placed on ‘real yields’ in the U.S., UK and other countries. SA yields have proven enticing for international investors.

"The search for yield should continue to benefit EM assets in the second half of 2020. However, due to domestic fiscal risks, we expect USD/ZAR to trade above its fair value, around a mid-point of 17.00 over the next few months, rallying to below 16.50 on positive global surprises and selling off towards 17.50 in response to global uncertainty," says Kim Silberman, a currency economist at Rand Merchant Bank in a recent note. "If growth in China remains supportive of commodity prices, as we expect, then USD/ZAR is likely to end the year at 16.50 despite the event and other risks between now and December."

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

Rand losses have been aided by mounting tension between the U.S. and China which have ordered the closure of consulates in each other’s countries over U.S. allegations of spying and intellectual property theft. 

Concerns about the impact on the U.S. economy of a second wave of coronavirus infections, ebbing fiscal support for households and the outcome of the looming November 03 presidential election have also at times played a role.

"The All Share closed 0.42% higher yesterday and has made gains of 3.1% for the month, however, by the end of today, this will probably be slightly lower. EM currencies are reflecting current market sentiment, falling overnight, with the rand 30 cents off its strongest levels against the US dollar, and we expect it to reflect this weakness for the day," says Siobhan Redford, a Rand Merchant Bank colleague of Silberman's. "As the weekend beckons, remember to observe social distancing protocols and wear your masks when in public. The threat, especially here in Gauteng, is now higher than ever. Stay safe and keep well."

Above: USD/ZAR rate at daily intervals but shown on an inverted scale alongside JSE All Share Index (orange line).

International factors weighed on emerging and developed markets alike although the South African government’s Thursday order for schools to close added to the Rand’s woes. South Africa’s coronavirus problem has gone from contained to uncontained, to bad and then worse throughout July as the number of infections more than doubled from from 159k to 408k on July 22, which has seen the country rise to fifth spot in the global size order of known infections.

Alcohol sales were banned again last Sunday and a nighttime curfew was imposed, although what might matter most for the Rand is whether these economically stifling measures and the evapouration of global risk appetite are able to put a dent into the domestic stock markets. 

“Although DM & EM FX tend to move simultaneously with equities, our analysis suggests that EM FX tends to move in the same direction as local equities, unlike DM FX. This is likely driven by both EM FX and local EM equities carrying large time-varying risk premia to account for idiosyncratic developments. Although a large portion of the EM FX move happens contemporaneously with local EM equities, we also find some evidence that FX is slower to adjust, providing an opportunity for investors to profit from the information content of relative equity performance with a short lag,” says Daria Parkhomenko, a strategist at RBC Capital Markets, who tips USD/ZAR for 17.10 by year-end.