Perfect storm gathering over the Rand: ETM warns of a looming shock

Key topics:US-Iran war and Hormuz disruption tighten global oil supply, creating deficit risk.South African Rand under pressure as terms of trade worsen, imports riseSA markets face JSE correction risk and bond sell-off amid global volatility.By BizNews Reporter.In the unforgiving arena of financial markets, there is simply no room for complacency. That age-old wisdom is especially pertinent right now, as a fluid and highly uncertain geopolitical drama unfolds in the Persian Gulf. For many South Africans, it might be tempting to view the ongoing conflict between the US and Iran as a distant problem. However, the excellent analytical minds at ETM Analytics have issued a stark warning to their institutional investors in their latest viewpoint: there are dire consequences to this war running longer than initially anticipated, and the longer it drags on, the heavier the price we will all pay. Specifically, a massive, asymmetric risk is currently building against the South African Rand.To understand the looming threat to the ZAR, we must first look at the mathematical reality of the global energy sector. The naval blockade in the Strait of Hormuz has essentially choked the world's energy arteries. ETM's analysis highlights that over 61% of the world's oil reserves are currently exposed to the Gulf or associated with problematic suppliers, and that roughly 44% of global production is similarly affected. Even if every other oil producer on the planet—including Russia—were to ramp up production substantially, they would struggle to plug the current supply shortfall of approximately 10 million barrels per day..Read more:.Morgan Stanley sees SA resilience despite oil price shock.The US Energy Information Administration (EIA) has already been forced to revise its initial expectations, delaying any inventory normalisation. What does that mean in plain English? They anticipate the drawdown in global oil inventories will last much longer than anyone initially hoped. With a massive daily drain of 8 to 9 million barrels a day, ETM estimates that some 700 million barrels have already been drawn down since the conflict began. In-house estimates place the cumulative storage lost by the end of June at a staggering 1.2 billion barrels, with some estimates rising to 2 billion. This is a colossal hit to the global system, estimated to be three to four times larger than any previous disruption on record..How does this distant oil shock translate to a vulnerable Rand? It all comes down to our terms of trade. There is currently a growing and dangerous disparity between the ZAR’s relatively resilient performance and the underlying fundamentals of the terms of trade. Put simply, the prices of the goods South Africa imports have surged. Conversely, the commodities that South Africa exports have suffered significant price declines. This dynamic acts as a vice grip, negatively affecting SA's trade and current accounts, a pressure that will eventually manifest in ZAR depreciation. Since the onset of the Covid-19 pandemic, the performance of the ZAR and SA's terms of trade moved in lockstep. But that solid relationship broke down at the onset of the US war with Iran. ETM warns that one of two things must happen: either the war ends swiftly, and our terms of trade improve, or the ZAR will inevitably depreciate sharply to reflect the bleeding trade balance..Locally, the South African equity market is dangerously ripe for a correction. Driven by resources and banks, the JSE has run hard, which was arguably justified over the past year. However, when stock market valuations stretch this far from their historical norms, the environment becomes highly susceptible to disruption and volatility. If the prolonged Gulf war undermines global GDP growth by fuelling inflation and forcing interest rates higher, the JSE could face a severe correction alongside global peers..Read more:.Katzenellenbogen on Iran: War dynamics, oil shock, global winners and losers.Even more critical to the currency, however, is the bond market. The bond market is orders of magnitude larger than the JSE, meaning foreign flows into and out of SA bonds heavily dictate the ZAR's direction. South African bonds have run extremely hard and served as a key driver of the ZAR's impressive strength over the past 12 months. But if global bond markets are rattled by higher inflation and interest rates, those strains will feed directly into SA bonds. A prolonged war dramatically raises the risk of a domestic bond market sell-off, which would pull the rug out from under the Rand..We are navigating treacherous waters. The oil futures market is already signalling that there is no imminent solution in sight. The curve, which previously priced in a quick normalisation of oil prices, now anticipates higher oil prices. While there are strong incentives for both the US and Iran to exit this war—Iran's economy faces a full-blown depression, and the Trump administration is losing popularity—the pain points are not yet unbearable enough to force a compromise.If we find ourselves months down the line with the war still raging and oil shortages biting hard, the global risk barometer—the VIX—will undoubtedly spike. Emerging market currencies like the ZAR simply do not tolerate high-volatility environments. As ETM logically concludes, if this war extends for another month, the downside risks to the ZAR build rapidly, and South African corporates must plan around this very real possibility..Sign up for your early morning brew of the BizNews Insider to keep you up to speed with the content that matters. The newsletter will land in your inbox every morning on weekdays. 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Perfect storm gathering over the Rand: ETM warns of a looming shock

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