South African Rand Retreat Comes after Foreign Investors Dump SA Bonds, but Damage to be Limited says Goldman Sachs

- ZAR loses ground in 2021
- Taper fears push Rand back
- Foreigners dump South African bonds
- But headwinds should ease says Goldman Sachs
- Goldman Sachs says local concerns over Covid remain elevated

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• GBP/ZAR spot at publication: 20.92
• Bank transfer rates (indicative guide): 20.19-20.33
• Transfer specialist rates (indicative guide): 20.77
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The South African Rand is being tipped to remain under pressure given the dual concerns that the U.S. Federal Reserve might start reducing support for the U.S. economy and that South Africa will miss its targets to vaccinate a significant portion of its population in 2021.

The Rand has fallen 4% against the Pound in 2021, while notching up a similar decline against the Dollar and 3.75% decline against the Euro.

The underperformance is said by many analysts to be linked to what is happening in the U.S., confirming the Rand's value is derived from both international and local considerations.

The U.S. Dollar has appreciated over recent days in line with rising expectations that the U.S. Federal Reserve will have to start withdrawing support to the economy at some point in 2021.

This is known as 'tapering'. The developments will ignite memories of 2013's 'taper tantrum', a reactionary panic amongst investors that triggered a spike in U.S. Treasury yields and the Dollar, after investors learned that the Fed was slowly putting the breaks on its quantitative easing programme.

"Speculation on the matter is going to continue over the coming weeks. Short-term a new fiscal package is likely to strengthen taper speculation so that USD is likely to remain supported for now," says You-Na Park-Heger, an economist at Commerzbank.

Above: GBP/ZAR daily chart showing price action since December 2020.

Should the U.S. economy start growing strongly and inflation start rising, the pressure on the Fed to ease back on its quantitative support measures will rise. This is an expectation given the looming inauguration Joe Biden who has promised inflation-boosting policies to support the economy and its people.

The side effect of a withdrawal in Fed support is that the yield on U.S.-issued bonds tends to rise - this in turn raises the cost of funding and the value of the Dollar.

Emerging Markets, such as that of South Africa, tend to benefit from a weaker Dollar and lower global funding costs, therefore developments in U.S. money markets have proven to be a headwind for the Rand of late.

Analysts at Investec say that foreign investors have dumped R7.1BN worth of South African Government bonds in 2021 thus far, a development that would establish downward pressure on the currency as repatriation flows emerge.

Above: Foreign investor interest in South African government debt (bonds) matters for the Rand.

Annabel Bishop, economist at Investec, says in the fourth quarter of 2020 foreigners purchased R6.1BN worth of South African debt on a net basis, "but then sold the entire amount in the first week of January."

As a result, the Pound-to-Rand exchange rate has rallied back to 21.00 this week, having been on the cusp of making a concerted break below 20.00 in December. The Dollar-to-Rand exchange rate went as far as 15.60 on Monday, having been as low as 14.60 at the end of December. The Euro-to-Rand spiked to 19.00, having been as low as 17.80 in December.

Despite the sudden loss in the Rand's purchasing power in 2021, analyst Zach Pandl at Goldman Sachs says the global headwinds that have emerged of late are unlikely to persist and ultimately coming months should see the South African currency supported.

"Fade the global headwinds," says Pandl in a note to clients out this week.

Goldman Sachs believe Emerging Market currencies - such as the Rand - can eventually appreciate as long as investor sentiment remains optimistic.

But this is possible as long as the pace of core rate increases moderates in the U.S. - i.e. another 'taper tantrum' must be avoided.

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However, Pandl and other economists warn that local headwinds are still a concern.

"After a strong run heading into 2021, two factors have driven the Rand significantly weaker versus the Dollar over the past week: one global, and one local."

"Extreme risk-on in financial markets in Q4.20 saw the domestic currency benefit, but a rollback to moderate risk-on, and then further risk aversion saw fundamentals come back into focus. SA’s fundamentals are weak, and particularly poor from a credit risk perspective," says Investec's Bishop.

On the local level, a new strain of Covid-19 which is more easily spread has been discovered in South Africa, making the headwinds to recovery grow stronger.

"While initial reports that vaccines may be effective against South Africa’s new virus strain are encouraging, South Africa still lags behind some other EMs in terms of vaccine purchase agreements, and the presence of a new variant places increasing importance on a timely vaccine rollout," says Pandl.

While vaccine purchases are ongoing, potential undershooting risk of the health ministry’s plan to vaccinate 67% of the population by end-2021 exists, says Pandl.

This makes for domestic downside risks to activity, to policy rates, and to the Rand.