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Harder times ahead for the rand as Ramaphosa rally fades

Dec 21 2017 07:43
Paul Wallace, Bloomberg News
Johannesburg - The South African rand’s surge lasted only as long as it took Cyril Ramaphosa to get himself to the top of the nation’s ruling party.

Now that he has, the currency’s world-beating rally is losing steam, and derivatives markets suggest it’s vulnerable to a renewed selloff.

The rand has climbed 14% against the dollar since hitting a one-year low on November 13, as investors bet that Ramaphosa would defeat his rival, Nkosazana Dlamini-Zuma, to take over the African National Congress and put himself in prime position to succeed Jacob Zuma as president in 2019.

The nation’s stocks and local bonds rose on Tuesday after Ramaphosa’s win and extended gains on Wednesday. But the rand traded sideways, suggesting investors want to see improvements to South Africa’s long-term prospects before increasing their exposure to an economy that’s barely growing and at risk of having its debt downgraded further into junk territory.

“The market has got ahead of itself as the victory of Ramaphosa does not spell the end of South Africa’s issues,” Guillaume Tresca, an emerging market strategist at Credit Agricole CIB in Paris, said on Tuesday. “It’s facing a turbulent period in the near future, which will make its assets vulnerable. Moreover, the medium- to long-term outlook is still not positive for the rand.”

Tresca recommended shorting the currency against the dollar and targeting a 7% drop to 13.61. The rand was trading at R12.75/$, 0.2% weaker at 07:37 on Thursday morning.

The price of derivatives allowing investors to benefit from a weakening of the rand has gone up. The premium of option contracts to sell the rand over those to buy the currency in the next three months, known as the 25 Delta risk reversal, has jumped more than 30 basis points in the past four days to a level higher than that of any major currency tracked by Bloomberg.

The rand’s implied volatility has plummeted since Ramaphosa’s victory. But its expected swings over the next month are still the highest among 29 emerging currencies followed by Bloomberg. That makes it a risky bet for carry traders, who borrow in low-yielding currencies to invest in higher-yielding ones, typically those of developing nations.

Adjusted for that expected volatility, the rand’s implied returns are lower than those of some of its closest peers such as the Mexican peso, Russian ruble and Turkish lira.

South Africa’s stock rally may be nearing its peak. The forward price-to-earnings ratio of the main banking index has climbed to 12.2, only just below the level of MSCI’s emerging-market index and far above its gauge for lenders in the developing world.

Foreign investors have poured R17.4bn ($1.4bn) into the country’s equities since the beginning of December. As the shares get more expensive, those flows may slow, adding to pressure on the rand because South Africa relies on portfolio traders to help plug its current-account deficit.

The rand can’t count on policy support either. After Finance Minister Malusi Gigaba’s budget speech in October, the currency tumbled and investors almost immediately priced in rate increases. That’s no longer the case. Forward-rate agreements beginning in 12 months fell below the three-month Johannesburg Interbank Agreed Rate on Wednesday, suggesting traders no longer see the central bank hiking rates over the next year.

Technical indicators are also signaling a correction is due. The dollar’s 14-day Relative Strength Index versus the rand dropped below 30, the level showing that a currency is oversold. The last time this happened, in March, the rand plunged 11% in the following two weeks.

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