Despite Mid-Week Relief, USD/ZAR Forecast to hit 14.00 before Friday

Mid-week foreign exchange trade sees the South African Rand regain some composure ahead of another potential step lower.

GBP/ZAR isat 16.80, down from a high of 17.35, the EUR/ZAR is at 14.40 down from a high at 14.87 and USD/ZAR is at 13.49 down from a high at 13.94.

While the ongoing relief rally will be welcomed we are warned that the declines might not yet be over as the market will now turn its attention to Moody’s rating decision scheduled for this Friday.

Moody’s currently rates South Africa at Baa2 (the lowest investment grade status).

“Thus a one notch downgrade from Moody’s would raise concerns about the eligibility of South African debt in investment grade bond indices,” says Petr Krpata at ING in London.

Foreigners have bought around US$1.2bn worth of South African bonds since the 15 March Fed decision and Krpata says they will now be underwater on both FX and the bond trade.

“The ZAR has one of the highest EM traded volatility prices for good reason. USD/ZAR to 14.00 before Friday,” says Krpata.

Analysts at UniCredit Bank AG agree that 14.00 is achievable near-term.

"We see upside risks to spot and it should trade with an upward bias within a 13.65-14.05 range in the near term," say UniCredit in a note to clients dated April 4.

Moody’s will likely downgrade the sovereign to Baa3 (the lowest IG rating) at their review on Friday, but this will likely have less of an impact than the surprise of the S&P move and the gravity of any potential action at Fitch.

"Instead, a downgrade by Fitch (which has the rating at BBB-) would be significant, as it would see two of the three main agencies with a sub-IG rating on the country, meaning that South Africa would come out of some of the IG bond benchmarks, resulting in selling by passive benchmark investors," say UniCredit.

Analysts at HSBC calculate that if S&P downgrade South Africa's rating it could trigger $9-10bn of outflows from the local bond market as the country would be removed from the widely followed World Government Bond Index.

The Rand took a sharp dip on Monday, April 4 after S&P cut South Africa’s long-term credit rating to junk (a one notch downgrade) leaving the outlook negative. Last week we reported that all major ratings agencies were likely to cut South Africa’s credit ratings in the near-term.

Policy continuity was cited by S&P as the core concern, following the removal of respected Finance Minister Pravin Gordhan last week.

But in a truly bizarre reaction to the news, South Africa’s Treasury responded that foreign capital would not be missed and the country would gravitate away from relying on foreign capital inflows.

The Treasury noted:

“Reducing reliance on foreign savings to fund investment and relying less on debt to finance public expenditure will secure South Africa’s fiscal sovereignty and economic independence.”

This suggests a Treasury being staffed by politicians who don’t have the slightest hint of how the country’s finances work and is truly terrifying.

“It was compiled by someone who doesn’t know anything about economics,” says Dawie Roodt, Chief Economist at the Efficient Group. “South Africa is a savings deficit country, even under former finance minister Pravin Gordhan, the state was a huge destroyer of capital. SA invests far more than we save.”