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Not one to mince his words, Investec economist Brian Kantor is this time sharpening his knife around the local currency. As is well known, it is due to weaker global forces rather than South Africa’s stronger ones that have taken the Rand and JSE higher.
And yet he says there is still more scope for improved local fundamentals to add further strength to both the currency and the economy. Yet another informative article supported by insightful graphs. – Stuart Lowman
By Brian Kantor*
The rand has regained all the ground lost since December 2015 when President Zuma shocked the markets.
How much of this recovery can be attributed to South African specifics (better news about the political state of SA) and how much can be attributed to global forces (less risk priced into emerging market currencies bonds and equities of which SA is so much a part of)? The answer is that to date almost all of the improved outcomes registered on the JSE and in the exchange value of the rand is the result of less global, rather than SA, risk.
The positive conclusion to draw from this is that were SA itself to be better appreciated in the capital markets on its own improved merits, there would be further upside for the rand – and for the SA economy that can only escape its current malaise with a stronger rand and the lower inflation and interest rates that will follow.
We show below that the rand has recovered in line with emerging market equities, represented by the benchmark MSCI EM. This index and the JSE indices are now also more valuable than they were in early December 2015.
The JSE All Share Index (ALSI) in rands is also now ahead of its December value. MSCI EM is up about 20% from its recent lows of mid-January 2016 while the rand has gained about 15% since then. The JSE, when valued in US dollars, has performed even better than the average emerging market equity market, having gained about 25% since its lows of 18 January.
(The line in these two figures indicates Dec 10th 2015 when President Zuma replaced his Minister of Finance)
The higher SA-specific risks attached to the value of the rand in December are shown by the performance of the rand against other emerging market currencies since.
As may be seen below, the rand has yet to recover its value of early December when measured against the Brazilian and Turkish currencies that have also strengthened against the US dollar over the period. On a trade weighted basis, the rand has lost about 4% since December.
A model of the daily value of the USD/ZAR that uses the USD/AUD and the emerging market bond risk spreads as predictors, with a very good statistical fit since 2012, indicates that without the Zuma intervention, the USD/ZAR might now have cost closer to R13 than the R14.5 it traded at yesterday (18 April), given the recovery in commodity currencies and the narrowing emerging market spreads.
USD/ZAR and its predicted value (explained by USD/AUD and EM CDS spread) Daily Data to April 15th 2016
That the recovery of the rand and the JSE has more to do with emerging markets rather than SA forces is shown below. Risk spreads attached to emerging market bonds and RSA dollar-denominated bonds have declined in recent months.
However the difference between higher emerging market spreads over US Treasury yields and RSA spreads has narrowed.
The wider this difference, the better the relative rating of SA bonds: the SA rating was at its relative high in late 2014 and has deteriorated since, though it is little changed from its rating of early December 2015.
A comparison of risk spreads attached to Brazilian and SA debt made below, shows how Brazilian credit has benefitted both absolutely and relatively to SA from the prospect that its President will be forced out of office. It should also be recognised that both Brazilian and SA debt are currently trading as high yield bonds. Investment grade bonds offer up to about 2.7% p.a more than five year US Treasuries.
When we turn to the bond market itself, we see that the yield on RSA 10 year rand-denominated bonds has fallen below 9% p.a but is still above the yields offered in early December. The spread between 10 year RSA rand rates and US 10 year Treasury Bond yields however remain above 7% p.a. This is a further indication that SA-specific risks priced into the bond markets remain highly elevated.
They reveal that the rand is still expected to weaken by about 7% p.a against the US dollar – implying consistently high rates of inflation in SA over the next 10 years.
There remains every opportunity for SA to prove that the markets are wrong about the inflation and exchange rate outlook, with policies that convince the world that we will not be printing money to fund government spending and that our policies will be investor friendly.
Of more importance, a stronger rand and lower interest rates would help lift GDP growth rates, to the further surprise of the markets and the credit rating agencies.
• Brian Kantor, chief economist and strategist, Investec Wealth & Investment.
