JOHANNESBURG — The global emerging market sell-off has tamed the rand in recent weeks, with weaker trading levels now the order of the day. However, as Investec Group Economist Annabel Bishop rationally explains in this analysis below, the rand would be in a much weaker position now if Cyril Ramaphosa hadn’t won the December 2017 ANC election. For now, Ramaphosa has luck on his side as it’s easier to improve South Africa’s situation following what was the disastrous, 9-year long Jacob Zuma era. That shine for Ramaphosa will wear off quickly though and sooner, rather than later, he’ll need to make more drastic economic policy decisions while possibly also cutting back on his Cabinet. These tasks are not easy in an ANC that is divided down the middle. – Gareth van Zyl
By Annabel Bishop*
On Friday the rand weakened to R13.29/USD, R15.63/EUR and R17.81/GBP, showcasing its inherent characteristic of volatility as an emerging market currency. Marked global risk-off has seen a substantial sell-off of EM debt in general, but the key point for the domestic currency is that it would likely be much weaker currently, indeed closer to R17.00/USD, R19.00/EUR and R22.00/GBP, without the Ramaphosa Presidency effect.
Last year, the domestic currency reached R14.57/USD, R17.07/EUR and R19.08/GBP in the run up to the ANC elective conference, then strengthened to R11.51/USD, R14.17/EUR and R16.08/GBP after Cyril Ramaphosa became President in 2018. South Arica’s domestic risk was seen to materially reduce, and global investor appetite for SA portfolio assets increased in comparison to other EMs.
If the rand had not strengthened to R11.51/USD, R14.17/EUR and R16.08/GBP this year, and instead returned to late 2017’s R14.57/USD, R17.07/EUR and R19.08/GBP and worse on a different election outcome, the rand’s subsequent weakness of around R2.00/USD, R1.50/EUR and R2.00/GBP would be coming off a much higher base. This would likely be pushing the domestic currency nearer R17.00/USD, R19.00/EUR and R22.00/GBP currently.
Foreigners purchased R32.3bn of South African portfolio assets, net of sales in the period January to April 2018. However, foreigners then sold R60.8bn worth of South African portfolio assets net of purchases in May and June to date, on global market risk-off as the transition to neutral US interest rates was seen to be becoming more advanced. Global risk-on switched to global-risk off and EMs in general were afflicted.
Indeed, the Institute of International Finance (IIF) shows EMs in general experienced this trend reversal in net foreign purchases/sales of portfolio assets. US$58.4bn of EM portfolio assets were purchased on a net basis in January to April 2018, and US$12.3bn net sold in May. India and SA are the two EM markets which have seen the biggest sell-off this year.
The risk of EM outflows has been heightened under US monetary policy normalisation, and the outflows are now occurring. Indeed, since the global financial crisis to April 2018, US$2.5trillion (IIF) flowed into EMs in a relatively low US interest rate environment. With the US seen as now reaching, if not breaching somewhat, its neutral interest rate level in 2020, markets fret over the possibility of a quickened US rate hike trajectory.
The FOMC meets over the next two days, with another 25bp hike expected. Key however, will be the tone of the statement, as markets worry over the possibility of a further elevation of the dot plot curve, or a seemingly more hawkish (is seen to lean towards more rather than fewer hikes) tone. With each word in the statement analysed, a perceived increase in hawkishness would spark further risk-off and EM currency/rand weakness.
The US is expected to see a gradual rate hike trajectory, and Wednesday night could well deliver a slight calming in FOMC market communication, but the down and extreme down cases of Investec’s scenarios (see table below) retain relevance due to the international risks of a further elevation in global market risk-off (as well as trade tensions, geo-political conflict, or even a global financial crisis).
We have (twice) reweighted the probabilities of South Africa’s scenarios since Q4.17 to reflect a marked tilt away from the previous heavy weighting to the downside in 2017. These earlier (Q1.18 and Q2.18) reweightings were driven by the decreased likelihood of additional credit rating downgrades and fiscal deterioration in SA – although the overall weightings for SA’s outlook was still towards the downside (if less so).
In May 2018 we revised the probabilities of the scenario table to reflect a greater tilt to the downside (see “MPC Preview”, 17th May 2018, website address below) to reflect the escalating risk of global market risk-off, and in June weakened our currency forecasts (see “Rand note”, 21st May 2018) in line with the escalation in the seasonal “sell-in-May and-go-away” phenomenon this year on heightened market sensitivities to the US rate cycle.
A number of EM interest rate hikes are now occurring, essentially to increase the attractiveness of interest rate differentials between emerging markets and developed countries, and South Africa is certainly unlikely to see any further interest rate cuts in the current risk-off period. While EM currencies could see some strength towards the end of this year as market players ‘return’ in September/October, and US dollar strength wanes, the risk is for heightened market, and so rand volatility in the near term.
This week’s FOMC meeting will likely give a clearer steer on market risk aversion levels, but heavy inflows into EMs since 2009 (US$2.5trillion since the global financial crisis to April 2018), weight the risk to the downside for EM currencies (and so the rand) as the US normalises its monetary policy over both this year and the next couple of years.
From a currency perspective, the risk is that we could need to drop the weighting of the probability back towards 40% for the expected case, and so raise the down case probability towards 30%, if it looks like a less gradual interest rate hike trajectory will materialise in the US than currently expected. Faster US growth elevates this risk.
Also heightening the risk for the down case, but from the domestic perspective, is the recent extreme weakness of the GDP outcome for Q1.18, which is credit negative given SA’s fiscal consolidation and social development needs. However, such a weak GDP outcome is not expected to be sustained into Q2.18, i.e. a recession, as it is largely due to base effects following strong growth at the end of 2017 (on recovery from the drought and the lift in global commodity prices).
Additionally, the lag between higher business confidence levels experienced in Q1.18 and investment and growth take a couple of quarters at least, and so little was expected to materialise immediately from this perspective in SA in Q1.18. Instead, the Q1.18 GDP growth outcome is reflective of the Q2.17/Q3.17 business confidence levels which were exceptionally suppressed in the run-up to the end-2017 ANC election.
- Annabel Bishop is Group Economist at Investec.