South African Rand Braced for Fresh Losses as US Trumps China With More Tariffs, but Potential Recovery is in Sight

- Latest US-Chinese trade tariffs a "litmus test" for the Rand.

- Market sensitivity to US tariffs waning, but ZAR is still vulnerable.

- Rand can still recover, once Dollar retreats and trade tensions ease.

Johannesburg, South Africa, Image © Adobe Stock

The Rand fell Wednesday and could be on course for another bout of steep losses after President Donald Trump instructed US trade representatives to prepare their largest round of Chinese trade tariffs to date, placing the so called "trade war" back in the spotlight and in the process putting emerging market currencies under fresh pressure. 

President Trump has instructed US trade representatives to prepare a 10% tariff on more than $200 billion worth of Chinese goods imported into the US each year, in a bid to force China into abandoning some of its trade practices the US alleges are illegal. US officials have previously threatened to follow these tariffs with more levies on an additional $200 billion of goods if China retaliates against the latest measures. 

This sent global financial markets into "risk off" mode Wednesday, with stock markets sinking into the red across Europe while safe haven assets like bonds were in demand, which has inevitably been bad for the emerging market currency complex. South Africa's Rand was quoted lower against all developed world currencies during the morning session, although early losses were more moderate than those seen back in June. 

The USD/ZAR rate was quoted 0.78% higher at 13.46 during the morning session Wednesday while the Pound-to-Rand rate was 0.80% higher at 17.84. The Rand was also down against all other developed market currencies. 

"We think markets are starting to pay lip service to the way that the US administration is conducting trade policy – and therefore subsequent stepwise escalations in the trade war will have a diminishing impact on global FX markets. We wouldn’t be surprised if risk assets quickly brush off this latest escalation in US tariffs – though the trade war playbook suggests one should look for the USD to trade higher against Emerging Market FX," says Viraj Patel, an FX strategist at ING Group.

South Africa's Rand is now down by close to 10% against the Dollar and Pound for 2018 but, given it had risen by a similar measure during the first-quarter, it has actually fallen by an even greater degree since the middle of April. Unease across financial markets over President Trump's "trade war", as well as a US economy that is going from strength to strength, have seen the Dollar emerge resurgent from the depths of a bear market this year. 

"We see the Rand as undervalued but in the near-term we are wary of further negative risks," says Shireen Darmalingam, an Economist with Standard Bank. "Financial markets have been on tenterhooks for weeks, with emerging markets the hardest hit. We watch for flare-ups in global trade frictions and changes in trade policies."

President Trump has placed tariffs on more than $250 billion of Chinese exports to the US in recent months and is pursuing restrictive legislation to govern investments into the United States from China. He says the measures are designed to reduce the US trade deficit and protect American companies' intellectual property from alleged theft at the hands of Chinese authorities.

The moves so far have drawn retaliation and threats of even further reciprocal measures from the Chinese. Fears are that a tit-for-tat tariff fight between the world's largest economies will quickly descend into an all out "trade war" and that this will dent economic growth in all countries it touches.

"Overnight news of Trump’s new tariffs will be a litmus test for the market. A large bout of weakness will confirm we not out of the woods, while a small move higher followed by a quick retracement will show a market that is suffering from headline fatigue," says Gordon Kerr, a fixed income strategist at Rand Merchant Bank, of the South African bond market.

A strong Dollar and market volatility are bad for South Africa and emerging market economies because they are hyper sensitive to changes in global risk appetite. In addition, emerging markets often turn to international markets for funding, with loans frequently denominated in foreign currencies, which means debt servicing becomes more expensive during times when the US Dollar is rising and Rand is falling.

However, while offshore factors may have made the greatest contribution, they have not been the only drivers behind the Rand's recent losses. A deteriorating domestic economy has also been at fault too.

"South African assets rallied strongly as a result of Zuma’s resignation, Ramaphosa’s appointment as Head of State, and the avoidance of a Moody’s downgrade to junk," says Crisitan Maggio, head of emerging market FX strategy at TD Securities. "But Q1 GDP growth was weak at 0.8% Y/Y and sentiment indicators such as PMI and Business Confidence, having risen sharply around the start of this year, have recently shown some signs of weakness."

The TD Securities FX team say South African economic growth should soon recover, as the newly minted President Ramaphosa reforms governance of the economy and the investment climate, which would then help lift the Rand over the coming months. But market concerns over US trade policy will first need to ease and the US Dollar go into retreat.

"We think the rand remains attractive, but will only start performing when emerging market sentiment reverses. We forecast USDZAR at 12.75 by year-end," Maggio adds. 

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