South African Rand Crumples as "Very Fragile Three" Lead Emerging Market Rout 

- ZAR in EM sell-off alongside TRY as China tensions, risk aversion rise.
- U.S.-China measures, profit taking make waves in thin August markets.
- RMB, Soc Gen warn weakness may endure even as gold price rallies.

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The Rand tumbled Friday as the Turkish Lira dragged emerging market currencies lower, encouraging a risk averse turn in sentiment ahead of the weekend that built on the back of crystalising U.S.-China hostilities. 

South Africa's Rand was trailed only by an under-pressure Lira on Friday as an ongoing depreciation of the vulnerable Turkish currency weighed on all supposedly fragile emerging market counterparts, leading to more-than 1% losses that some fear might endure through the coming week.

"The risk of a new implosion in Turkey could weigh on market action over the coming week. EUR/USD keeps TRY(ing) to break higher but an escalation in the TRY sell-off could prove to be a short-term game-changer for both EUR/USD and risk assets," says Andreas Steno Larsen, chief FX strategist at Nordea Markets. "If Turkey implodes again it will be more of an issue for the EUR than the USD since some big southern European banks hold large exposures in TRY, although less materially so than in 2018. We see this as a potential trigger for a setback in EUR/USD towards the 1.1530 zone."

Losses mounted as the Dollar turned higher ahead of the weekend and following days of yet more punishing declines for the U.S. unit, with the move in the greenback having roots in an overnight executive order from the White House aimed at the Chinese-owned and controlled TikTok social network.

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

Transactions with TikTok's owner Bytedance will banned 45 days from Friday for U.S. entities, a decision that's thought to be aimed at speeding up a divestment of the company's U.S. social network. China's WeChat network, which is owned and operated by a separate company, was also subjected to a similar order.

In addition, the U.S. administration also reimposed import tariffs on Canadian alluminium, further undermining risk appetite that was already fragile to begin with, stoking demand for the Dollar and losses for most other currencies. 

The Rand was lower against most rivals but its largest losses came against the majors and India's Rupee, with USD/ZAR rising above the 17.50 level while the Pound-to-Rand rate regained the 23.0 threshold. 

"The JSE should follow the negative trend today as there is significant uncertainty in the global market, but could see some downside limitations as the gold price remains above the US$2,000 level," says Siobhan Redford, a currency economist at Rand Merchant Bank.

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

RMB looks for a third-quarter consolidation for USD/ZAR in a narrow 16.50-to-17.50 range but said Friday that weakness could continue in the short-term. August is typically a bad month for emerging markets, although the bank also says the local unit is unlikely to deviate too far from 17.50. 

"Over the last 20 years, the best August trade was to buy gold against the rand, for an average 5% return. It's up more than that already this month. If it repeats the trick for a couple more years, I'm going to market an August ETF to trade it and finance my retirement," says Kit Juckes, chief FX strategist at Societe Generale. "It's striking that the volatility and the ‘normal' seasonal moves are concentrated in EM. The very fragile three - TRY, ZAR, BRL, are down by an average of over 3% against the dollar." 

Risk aversion has denied the Rand any benefit from ongoing signs that the coronavirus is losing momentum in Africa's second largest economy, with a downtrend in the number of new infections detected each day having endured into August but gone largely unrewarded by investors. 

The domestic currency has also gotten little help from rising gold prices this week, even as what is one of the country's largest exports provides a consolation to its troubled economy, which reflects a long-established tendency toward risk aversion that tends to lift safe-haven assets while weighing in risk currencies during the August month.

"USD/ZAR formed another bottom at 16.3434 in July, having made a previous one at 16.3613 in June, and is gunning for the June high at 17.5311. Were it to be exceeded on a daily chart closing basis, a bottoming formation would be formed with the early and late April lows at 17.8433/18.0108 then being targeted," says Axel Rudolph, a senior technical analyst at Commerzbank. 

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

Gold has risen on both the good and bad days for risk appetite since the Dollar is in a sustained downtrend but once calm returns, such higher prices could provide the Rand a tailwind of support that again leaves it a relative outperformer among emerging markets, given that precious metals and gems are South Africa's top exports.

"As a result of growing debasement risk, DM investment demand strength has continued with ETF additions in both Europe and US running high. We see this trend persisting for some time as investment allocations into gold increase inline with allocations to inflation protected assets, similar to what happened after the financial crisis," says Jeffrey Currie, head of commodities research at Goldman Sachs, who has a 12-month forecast of $2,300 for gold and $30 for silver. "In addition, the stretched valuations in equities, low real rates and high level of economic and political uncertainty all point toward continued inflows by high net worth individuals, in our view."

Central bankers have flooded economies with new currency to cater for governments' simultaneous, extraordinary funding requirements that riled bond markets before policymakers stepped up in earnest back in March. As necessary as their actions may have been, they've also revived previously dormant fears about what such expansionary monetary policies might mean for inflation and the value of currencies over time. 

Precious metals have long been viewed as a safe-haven currency of last resort although less appreciated is often the protection offered by stock markets, which reflect the perceived future value of corporate cash flows that can adjust along with product prices in response to future inflation. Such qualities may explain at least a part of the speed and scale of the rallies seen by stocks, which also began in March when central bankers turned the money taps on. 

"The deflationary shock caused by the pandemic drives the need to expand balance sheets to support demand today, as seen in the latest US $1.0 trillion Phase 4 stimulus and the €750 billion pan-EU recovery fund. The resulting expanded balance sheets and vast money creation spurs debasement fears which, in turn, create a greater likelihood that at some time in the future, after economic activity has normalized, there will be incentives for central banks and governments to allow inflation to drift higher to reduce the accumulated debt burden. Indeed, this has already been seen in recent FOMC minutes, as discussions of explicit outcome-based forward guidance raises the prospect for Fed-sanctioned overheating of the economy," Currie says.

Above: Gold price and silver price (orange line, left axis) shown at daily intervals.