Rand Retreats As a Resurgent US Dollar Sideswipes Emerging Market Currencies
The Rand was weaker going into the Friday close in London after being blindsided by a stronger US Dollar.
The Dollar rose Friday on bets that President Donald Trump’s proposed tax cuts and reforms may eventually make their way into law after the Senate passed a key budget that was seen as the first step toward getting the reforms ratified.
John Cairns, a foreign exchange analyst at Rand Merchant Bank, says the Rand is back to taking its cue from broader global macro themes rather than domestic events for the time being.
Indeed, this may well be the case until the end of the year when the ruling ANC party holds its leadership election in December, which will determine the party’s new leader, and the likely future replacement of President Zuma.
That said, a November review of South Africa’s credit rating will be another key driver of the currency.
There have been concerns that the country may be downgraded and lose its investment-grade status however, few experts think this will happen in 2017, if it happens at all.
South African Reserve Bank (SARB) governor Kganyago was the latest South African official to dismiss suggestions there might be a downgrade in the near future.
On Friday he “a narrowing current account deficit, improving economy and stable inflation” as grounds to think a downgrade will be avoided. and because
“Even if government misses their revenue target, you are not going to see fiscal deficits like we saw at the time of the recession in 2008, when the deficit shot up to 6.8%,” Kganyago says.
So the greatest threat to the Rand for the time being will remain the US Dollar, whose own outlook is growing ever more bullish, or so some are suggesting.
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New Party Leader Could be Catalyst for Rand Gains
The South African Rand could rise over the next three months as president Jacob Zuma's tenure as ANC party leader comes to an end and members vote for a potentially more 'market-friendly' replacement, according to a report by investment bank Credit Suisse.
The currency is also likely to be supported when South Africa's credit rating is reviewed as concerns it may be downgraded are unlikely to materialize, according to strategists.
Finally, an overall rangebound Dollar, which has a high negative correlation with the Rand, is likely to further support the currency as it stifles trend development in either direction.
This is reflected in the close correlation between USD/ZAR and US Treasuries as illustrated in the chart below.
These are the main factors leading Credit Suisse Strategist Nimrod Mevorach to forecast USD/ZAR falls to 13.00 (from current 13.52) in 3 and 12 month's time.
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Filling Zuma's Shoes
The ANC will decide who to replace Zuma with at their December Elective Congress which is likely to be a "binary event'" both for the economy and the Rand, according to Credit Suisse - which means it could cause a lot of volatility.
The event was a two horse race between Zuma's ex-wife Nkosazana Dlamini-Zuma (NDZ), who represents the status quo, and deputy leader Cyril Ramaphosa (CR) who is an anti-corruption reformist. But now, a third compromise contender in the form of the Zweli Mkhize (ZM) has taken the middle ground.
There is no clear favourite at the moment and due to the complex voting system it is very difficult for strategists to predict who might win.
"There is a good chance that markets will only have a good idea on who is going to win this race only very close to the end. That is due to the highly-complex ANC voting system and the nature of the politics around the Conference," said Mevorach.
As far as the Rand goes the most positive outcome would probably be a victory for CR as he is more likely to let the South African Reserve Bank remain independent. He is the most modernising and free-market orientated and the least comparable to Jacob Zuma, who has become a weight on the Rand.
A CR victory in December would probably lead to a 15% rally in the Rand according to a recent note by Nomura's FX Strategist Henrik Gullberg.
A win for Zweli Mkhize, the compromise candidate, would result in a 10% rise in the Rand. So toxic is Zuma for the currency, however, that a continuation of the status quo in the form of his ex-wife Nkosazana Dlamini-Zuma would be the least positive for the currency and USD/ZAR rising to 14.25 -14.50.
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Downgrade Unlikely
One major potential headwind on the horizon for the Rand is a November review of the country's credit rating.
"Credit rating reviews by S&P and Moody’s (both 24 November) are probably the most concerted risk-event for the rand before the ANC’s Conference," says Mevorach.
South African debt is perilously close to losing its investment grade status, which means it would become known as "junk". If this happens, many investment funds will not touch it and there could be a massive fire sale of SA bonds by foreign investors, leading to the Rand rolling off a cliff-edge.
"A downgrade/s could trigger outflows from South Africa’s local currency bond market (SAGB) due to index rebalancing. For the rand that could also prompt unwinding of un-hedged positions. The index inclusions that are at risk are," said Mevorach.
However, the Credit Suisse base case forecast is for SA to hold onto its investment grade status, at least in the current year anyhow.
"For now we think that USDZAR is going to trade largely on global factors (i.e. broad USD trends and metal prices). We also go with the base case that neither Moody’s nor S&P will downgrade South Africa in November. Our economist thinks that rating agencies are most likely to wait for next year before potentially delivering a downgrade," said Mevorach.
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