South African Rand: Traders Now Walking Away as the Good News is in the Price

© Chris Titze Imaging, Adobe Stock

Price action this week shows all of the good news is already baked into the Rand, suggesting President Ramaphosa will need to deliver concrete policy changes before the currency can rise further.

Traders are walking away from bets on South Africa’s Rand following a week of poor performance, which has taken place against a backdrop of deteriorating market conditions and returning political risk, sapping the currency's earlier momentum.

TD Securities, a Canadian investment bank, is the latest to jettison bets in favour of the Rand, which enabled strategists to book a 2.5% profit in their model portfolio Thursday.

They have closed their trade despite it not having reached the USD/ZAR target price of 11.30 they set out to achieve a few weeks ago.

“The reason we are closing this trade ahead of time, and in spite of not having achieved our second 11.30 target (after achieving 11.70 on 14 February), is that rand longs have been bleeding performance for several days on the heels of adverse market conditions and the reversal of the prior positive momentum,” says Cristian Maggio, head of emerging market FX strategy at TD Securities.

“This latter aspect is likely to be driven by profit-taking after a long ZAR run this year and last. With ZAR the worst performer in the EM FX space over the past week (-1.8% vs USD), we prefer to lock in a larger profit rather than allow the pair to hit the stop at 12.00 and further erode positive P&L.”

The USD/ZAR rate was quoted 0.67% higher at 11.86 during morning trading in London Thursday while the Pound-to-Rand rate was 0.62% higher at 16.31.

South Africa's Rand had performed strongly up until the opening of the current week, rising by double digits against the Dollar and Pound over a three month horizon, although now it has begun handing back some of those gains.

Fresh Political Risk in South Africa

Unfortuntely, for the Rand, the first significant policy change backed by the Ramaphosa regime is the expropriation of land without compensation. 

The confiscation of property - in whatever form, under any guise - sends a clear signal to investors - your investment's in South Africa now have a degree of political risk attached to them.

The populist policy is seen to be an overture by the ANC to the radical EFF who have long advocated for compulsory seizures of land without compensation, something that has appealed to the poorest in society.

South Africa’s Rand was seen lower against its rivals mid-week, with the Pound-to-Rand exchange rate quoted at 16.30 having opened the week having been as low as 15.98 alread this month. The USD/ZAR was quoted at 11.72, having been as low as 11.53 this month.

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Cabinet Reshuffle Misses the Spot

ZAR was pushed lower against its international rivals in Tuesday as markets responded to a late night cabinet reshuffle by President Cyril Ramaphosa.

The eagerly anticipated shake up of the South African government’s top team comes barely a fortnight after former President Jacob Zuma stepped down putting Cyril Ramaphosa into the top post on a pledge of economic and political reforms.

This shuffle saw embattled finance minister Malusi Gigaba nudged aside, and put back into the home affairs role, with one-time finance minister Nhlanhla Nene reinstated in his place.

Gigaba’s replacement comes just one week after his presentation of the February budget statement was well received by ratings agencies.

Pravin Gordhan, South Africa’s former finance minister who was forced aside by then-President Jacob Zuma in 2017, was appointed Minister of Public Enterprise. Gordhan was previously seen by the market as a worthy finance minister, whose firing left ratings agencies concerned.

He will now lead the government’s efforts to improve governance at state owned enterprises such as power utility Eskom. Shoring up market confidence in governance at Eskom and other state firms is crucial to South Africa being able to keep and then retain its last remaining investment grade credit rating.

“We expect a sensible market reaction and for rating agencies to view the new configuration as positive, especially with Mr Nene back as finance minister and Mr Gordhan as public enterprise minister — this combined with the changes in leadership at Eskom,” says Isaah Mhlanga, an economist at Rand Merchant Bank.

The South African Treasury is on the hook for as much as ZAR 350 billion (£21 billion) of Eskom’s debt and a further ZAR 330 billion of additional debt held by other state owned enterprises. A total ZAR 680 billion of government debt guarantees are equivalent to around 10% of South African GDP.

Still Some Question Marks

Despite positive implications of the reshuffle, the Rand was seen weaker, even as South Africa’s ten year government bond yield ticked higher by a few tenths of a percent, to 8.07%, suggesting that the Rand’s fall is mostly the result of domestic factors.

“Media reports and indeed some market participants have labelled the new cabinet as a compromised configuration because many individuals who are alleged to be incompetent or implicated in state capture remain in office,” RMB’s Mhlanga notes.

“That may very well be true but this ignores the fact that President Ramaphosa still needs to win a general election next year, and to the extent that some of these ministers can help deliver an election.”

The continued presence in the ministerial team of some who were implicated in corruption allegations may have left a sour taste in the mouths of traders Tuesday.

A case in point would be former finance minister Mulasi Gigaba, who has moved back to his previous role in home affairs, which is where he was when many of the corruption allegations levelled against him first emerged.

News 24 claimed Tuesday that Gigaba used his earlier position in home affairs to the benefit of controversial Indian business moguls, the Gupta family.

It’s alleged that Gigaba enabled members of the Gupta family to secure South African citizenship even though they did not meet the requirements. There have been a host of other allegations levelled at him.

Credit Rating in Focus

Tuesday’s reshuffle and subsequent price action comes a week after the February budget was seen placing South Africa on a slow and winding path to a lower budget deficit, in the hope of averting a downgrade of the nation's credit rating.

Moody’s put South Africa's local currency credit rating “on review for downgrade” back in November, citing a rising budget deficit, a deteriorating growth and fiscal revenue outlook. The government’s poor record on economic policy and governance of state owned enterprises were also issues too.

Many now expect South Africa has done enough to avoid a downgrade, given the change of political leadership and revenue raising measures set out in last week's budget.

However, if a downgrade is averted South Africa will have to ensure it goes onto retain its rating throughout future reviews, which will require faster economic growth and progress toward bringing down the deficit.

A loss of investment grade status could be devastating as it would see many institutional investors forced into selling their government bonds. This would push South African borrowing costs higher and put downward pressure on the Rand once again as foreign investors flee the country.

“Macroeconomic and fundamental amelioration of South Africa is a slow process that will take years to unfold successfully, assuming all advances smoothly. All the premises for a successful economic transformation of the country, however, are already here today,” says Cristian Maggio, head of emerging market strategy at TD Securities.

Good News in the Price

Put all the above together, and we see much of the good news is already priced into the Rand, suggesting President Ramaphosa and the new cabinet may need to deliver some goods before the currency can resume its push higher.

“The market has heavily rewarded the Rand, which, since 31 October 2017, is by far the world's best performing currency (up 22% vs USD to 11.58 at the time of writing),” says Maggio, flaggin the market’s response to series of events that began with Moody’s having given South Africa a stay of execution back in November.

“We remain optimistic on short-term developments and expect USDZAR to fall to 11.30, but have a moderately more bearish forecast for quarter-end at 11.85 and Q2 at 11.70.”

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