Rand braces for punch as SA downgrade no longer 'if' but 'when'

Cape Town - One local currency downgrade on Friday would push the dollar/rand exchange rate up by between 30 cents and 50c in a rapid spike, John Cairns, a currency economist at Rand Merchant Bank (RMB), said on Monday.

"This would be a much bigger move than seen after previous downgrades," he commented on Monday.

Both S&P and Moody’s have reviews scheduled for Friday November 24.

"If S&P and Moody’s both downgrade, then we can expect far greater losses — perhaps even between 50c and 100c. Our market surveys and the pricing on offshore bonds show that downgrades are expected, but this is probably priced for mid-2018 and not as soon as this week," commented Cairns.

He added that the recent losses in the bond market do not match what would be expected if the market was positioning for World Government Bond Index (WGBI) outflows.

RMB puts the probabilities of a local currency rating downgrade on Friday evening at 40% for S&P and 10% for Moody’s. Fitch, which does not release its review dates, might also make an announcement this week. Cairns said Fitch is far less of an issue for the market, given that the agency already has the sovereign on sub-investment grade, which is not a determinant of WGBI inclusion.

"The rand strength of late last week can be ascribed to an unwinding of negativity, dollar weakness, the stories that [Deputy President Cyril] Ramaphosa is in the lead in the nomination process and even possibly some optimism about the situation in Zimbabwe," explained Cairns.

"Some of the positives will probably remain this week. However, we would not push the rand too far. At current levels, the rand has not only unwound the losses associated with the free-higher-education rumours, but also — relative to other risk currencies — most of the losses seen after the budget."

In his view, global issues are likely to play less of a role in the rand this week. The main issue for the rand remains the value of the dollar.

RMB analyst Gordon Kerr said Friday’s bond flows were just another example of how sensitive the SA market is to any “political noise”.

"With the SA Reserve Bank (rates) decision on Thursday, and the US off for Thanksgiving on the same day, this could turn out to be a quiet week in the markets," said Kerr.

Mike van der Westhuizen, portfolio manager at Citadel, said on Monday that SA’s downgrading is no longer an “if” but a “when”.

"While both S&P and Moody's' recent rhetoric has pointed to a wait-and-see until after the ANC elective conference approach, it would not be surprising to see at least one of them pull the trigger sooner rather than later," commented Van der Westhuizen.

"However, more likely, we could see South Africa’s local currency bond rating be put on review for a downgrade on 24 November, in which case the rating agency has 60 to 90 days to make the move, a period which covers both the ANC elective conference and the February 2018 budget."

He added that the negative outlook from the prior downgrade - S&P in April 2017 and Moody’s in June 2017 - needs to be resolved within 12 to 18 months, meaning, in his view, that a downgrade before the end of the first half of 2018 is "inevitable".

"On the downgrade front, it can be argued that since the mini budget the currency and bond markets have already priced in an imminent downgrade," said Van der Westhuizen.

"Naturally the market could overreact to a confirmation that SA is officially sub-investment grade. In addition, if one was to factor in potential bond index exclusion from further downgrades, a large portion of the wall of money that has flowed into SA can just as quickly exit."

In his view, this would almost certainly lead to further bond and currency weakness. On the other hand, one could see some short-term respite if the ratings agencies delay the fate, he added.

"The bottom line is that SA needs pro-growth economic policy that is actually implemented and not just a regurgitation of a 'wish list'," he emphasised.

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