Rand Review – September 2020 written
Risks to the South African Economy and Currency
South Africa, it’s economy and thus its currency remains exposed to substantial risks in the short, medium and long-term.
Two intertwined factors raise the greatest existential risks. Factors which, for the moment, remain partially under the control of the South African government.
Unless government expenditure is reined in, now, the economy faces the prospect of uncontrollable expenses in the name of the Public Sector wage bill and debt-servicing costs.
Public Sector Wage Bill
1.2 million now work in the public sector. The annual wage bill is projected to reach ZAR 700 billion by 2022/2023 on the unrealistic assumption government (the ANC) has the will to reject public sector union wage demands.
Debt Servicing Costs
Debt-servicing costs are projected to rise ZAR 300 billion by 2022/2023 up from ZAR 157 billion in 2016/17. National Treasury’s assumptions which are used to forecast these, and other numbers are gently speaking, optimistic.
Source: National Treasury
Source: National Treasury
The government does not remotely have the will or the capacity to make the wage bill and debt-servicing cost projections come even close to realistic.
If the government has proven incapable of holding the line, in better conditions than exist today, on bailouts for SAA, SABC, SAPO, Land Bank and Eskom then their commitments today should ring equally hollow.
Global Central Bank QE & International Inflationary Expectations
Already the battle lines are drawn in the unspoken but deadly serious duel to weaken the domestic currency in order to stimulate growth through trade advantage.
All the QE air and they still could not blow the inflation house down. There is very little prospect that ever larger Central Bank balance sheets will do the trick. Assuming that it will is the oldest game of banging your head against a brick wall to if it will feel any different the next time.
A positive story from the Basis Swap Market
This chart and table indicate that one-year dollar funding conditions for South African banks and corporates have improved substantially since April by 69.50 bps (39,50 –(30))
Very simply a basis swap is a tool that banks use to be able to switch from RAND funding into US Dollar funding.
The more negative the swap number the more difficult funding conditions are.
In the midst of the market chaos in March & April rates went very negative. As the markets/economy have recovered bank funding pressures has abated.
That is much needed vote of confidence for the South African banking system.
A more negative story from the Currency Options Market
In contrast to the positive story on the availability of daily funding the currency options market is still biased towards Rand weakness across all maturities to the one-year date.
A simplistic way to interpret this chart is:
Rand ‘depreciation’ options, in the top right-hand quadrant, are expensive and should be sold
Rand ‘appreciation’ options, in the bottom-left quadrant are cheap and should be bought
Exporters, which always need to have a suitable hedge structure which commits to selling US Dollars, are ideally positioned to take advantage of this bias through various option structures that we can advise on and facilitate.
How about our credit?
South Africa’s credit worthiness has suffered very negatively over the last year.
The market is implying there is a 16.00% likelihood that the South African will default on its obligations within the next 5 years.
How to go from investment market darling to junk-yield joke in one easy step.
A synopsis that we can take away from the three alternative capital market products is that there is a multi-faceted view of South African economic and financial prospects.
We will continue to monitor those markets and products immediately bringing to your attention any seismic shits which will warrant a dramatic shift in our expectations for the currency and interest rate markets.
South African Reserve Bank MPC Rate Announcement (17th September 2020)
The SARB are truly in a bind. Rates are the lowest in perhaps two generations, but there is little else they can do to stimulate the economy from a monetary policy perspective.
All the major impediments to economic growth and fiscal prudence lie with central government.
The SARB can advise and recommend but that is the extent of their impact and reach.
Happily, with inflationary expectations set extremely low there is no immediate imperatives to be on the lookout for breaching inflationary targeting mandates.
Producers and consumers alike are dead on their feet.
Although we believe the SARB will lower rates on Thursday its impact will be psychological rather than of practical assistance.
Long-term trade weighted perspective on the Rand
Not to be unkind but this look like a floating brick, particularly since 2010.
Short-term prospects for the Rand
The short-term future need not look like the medium or even long-term past. There have been periods of Rand strength that have been largely unanticipated by a trading and hedging that has become conditioned to extreme pessimism.
With that in mind the Rand is at a very interesting juncture right now. Since all-time high just above 19.0000 in April the Rand has pulled back significantly to trade within ever tighter ranges, lastly between 16.5000 on the base and capped by 17.3000 on the top.
Lower levels since the April high have been consistent with broad dollar weakness and stronger European currencies as the following charts will show.
Although the Rand found solid support at 16.5000 over the last couple of months it broke lower on the 15th. Any extension of this move lower is dependent on externalities, such as whether a global risk on trade is maintained and extended.
Euro and Dollar Index
The financial press is cheerleading a further move high in the Euro, but we know that this is already a crowded trade.
From a technical standpoint, it’s possible to count a completed three-wave (A/B/C) structure including the wide-ranging moves in March.
If the Euro holds significantly below 1.1960 then our view that the next large move in Euro will be down remains in place. A higher Euro would be consistent with an extension of the Rand to lower levels against the US Dollar as international ‘Tourist Money’ chases higher yield.
By the same token, a lower Dollar Index implies funds flowing out of unquestionably overvalued US assets and into other destinations, which may include South African bonds.
Hedging Strategies in the light of the above
A sustained break of 16.5000 gives importers a much-needed opportunity to cover foreign denominated liabilities. Together with lower Repo rates from the SARB and the closely linked money market rates will make forward cover considerably cheaper than has been available for most of this year.
This is not the time to second guess things – if you need to buy foreign currency then this is a good time to start accumulating hedge cover
Late to market exporters will inevitably have found the market has slipped away from them with this latest move.
For extremely price sensitive corporates who trade in extremely competitive markets covering in the forward market even at these lower levels is a must.
For exporters who have a higher risk tolerance, we have suggestable option related derivatives structures which offer help to an exporter as they can sell highly priced dollar call options to fund the purchase of less expensive protective put options.