South African Rand: "Short-Term Euphoria" Will Change to "Cloudy Sky" say Julius Baer

- ZAR has risen, supported by easing political risks and a narrowly-missed ratings downgrade 

- Risks are now tilted to the downside, says Julius Baer

- The SARB meeting on Wednesday (tomorrow) is a near-term risk factor for ZAR

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The South African (SA) Rand has rallied quite strongly over the last few weeks supported by an improving political landscape, however, its time in clover may be over, according to Julius Baer.

South Africa also narrowly avoided having its credit rating downgraded last Friday which would have meant its debt being downgraded to 'junk' status and a bloodbath for the Rand - as it was it never happened and the Rand rallied. 

Investors service Moody's decided, instead,  to take SA off their danger watchlist and raise the outlook to 'stable'.

Yet despite these positive events, longer-term headwinds mean the recovery is unlikely to last, according to Anabelle Rey, an analyst at Julius Baer.

The replacement of President Zuma with Cyril Ramaphosa in December, was seen as a positive by markets, yet all the good news has now been priced in, says Rey.

"We believe that the high hopes around the end of Zuma era are now essentially priced in," says the analyst, "moreover, South Africa’s fundamentals remain rather weak: stagflation; high unemployment; weak fiscal outlook and the risk of further rating downgrades, should still weigh on the ZAR," she adds.

Markets are overlooking the inconvenient details when it comes to the new administration which suffers from inherent vulnerabilities.

"Factional divisions within the ruling party could prevent Ramaphosa from quickly implementing the reforms he has promised," says Rey.

From a pure 'fair value' perspective, which is the theoretical 'true' value of a currency, the SA Rand (ZAR) is also now, no longer undervalued as it was before, in fact, "it has become rather expensive," says the analyst.

Rey recommends selling, or 'shorting' the ZAR with a stop loss at USD/ZAR 11.25, preferably against the USD, which is due for a rebound.

But what of ZAR versus the Pound? Julius Baer observe the Bank of England is now sounding more 'hawkish' - i.e. they are looking to increase interest rates, which as a rule of thumb is a positive for the currency. An interest rate rise in May is expected, but it is noted that the Pound’s reaction remained limited, as a rate hike this year is already priced in.

As such, the bank maintains a neutral GBP outlook despite prospects for higher UK rates.

Our own technical studies of GBP/ZAR reveal a neutral outlook too and can be accessed here.

The meeting of the South African Reserve Bank (SARB) on Wednesday, March 28 (tomorrow), however, is a negative risk event for ZAR, since analysts widely expect the SARB to cut interest rates by 0.25% to combat falling inflation.

Lower interest rates tend to drag on a currency as they attract fewer inflows of foreign capital which prefer currency jurisdictions where interest rates are higher and they stand to earn higher returns.

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