Despite ratings downgrade, demand for local bonds boosts rand

Cape Town - Contrary to predictions that the rand stood to incur moderate further losses on Monday, the currency was getting stronger against the dollar during the course of Monday morning.

By early afternoon trade the rand was already 2.02% stronger at R13.75 to the dollar. By contrast, the rand weakened by about 30 cents to the dollar on Friday.

TreasuryOne dealer Phillip Pearce told Fin24 that demand for local bonds, despite being downgraded, has attracted massive interest.

"Investors have decided that the return on offer outweighs the risks highlighted. The portfolio inflows have bolstered the rand as it is apparent global markets are yield hungry in an environment of persistently low interest rates in the face of lackluster inflation," explained Pearce.

Bianca Botes of Peregrine Treasury Solutions told Fin24 on Monday that all the anticipation of a potential double downgrade of SA on Friday has likely led the market to perceive the news of a single downgrade as rather positive.

She said it also seems as though sentiment towards the South African political landscape is shifting to that of a more “investment friendly” one, with the ANC election conference being just around the corner.
"While the rand firmed by over 1.7%, we do believe that there is still tremendous risk in an environment that generates very little economic growth, while being subjected to massive potential outflows," said Botes.

"Bearing in mind that the rand traded close to R14.60 just over a week ago, we would urge people to make use of these beneficial rates."

Jameel Ahmad of FXTM told Fin24 that the catalyst for the recovery in the rand is likely linked to a round of dollar weakness in the markets on Monday. The dollar has also drifted lower against the euro, British pound and specifically the Japanese yen during trading.
"The markets are preparing for the senate budget committee being scheduled to meet on tax legislation on Tuesday and it’s possible that concerns over President Donald Trump’s tax plan already being priced into the market could be driving weakness in the dollar," said Ahmad.

Earlier on Monday it was estimated by John Cairns and Isaah Mhlanga of Rand Merchant Bank that the rand will likely suffer some further moderate losses on Monday.

"Expect volatile trade on Monday as the market tries to find a new level after Friday's rating reviews. Our best guess is that the rand will finish only a little weaker after having suffered some explosive moves early on," said Cairns and Mhlanga.

"Last Friday’s ratings actions confirm what we already knew, it was just a matter of time. Early trade (on Monday) is likely to be volatile as Johannesburg and London markets adjust to the change."

The rand opened the week at R14.10 to the dollar, R16.81 to the euro and R18.78 to the pound.

S&P Global downgraded South Africa's long-term sovereign credit ratings by one notch, foreign currency to BB (two notches into sub-investment grade) and local currency to BB+, with a stable outlook.

Moody's Investors Service placed the sovereign's Baa3 (the lowest investment grade rating) foreign and local-currency ratings on review for a downgrade, with a decision to follow the February 2018 budget. Fitch already rates both the foreign and local currency at BB+ with a stable outlook.

Worse than expected

"These decisions were worse than what we and the market had expected," said Cairns and Mhlanga.

"The one-notch local-currency downgrade to sub-investment grade by S&P implies that SA bonds will fall out of the Barclays Global Bond Index, with estimated outflows of up to $2bn. This is not hugely problematic for the rand market. However, the market’s pricing of a full downgrade by Moody's, and so the exclusion from the World Government Bond Index (WGBI), will grow and become a key constraint to any push stronger in the rand."

They believe that in the absence of any political shock, confidence might return to the market towards the end of this week.

According to TreasuryOne, the rand's 30c loss on Friday due to the rating decision could have been worse if the dollar had not been on the back foot. The dollar hovered near two-month lows as the Federal Reserve expressed caution over the lack of inflation.

"The focus for the rand is now on the ANC elective conference where both Nkosazana Dlamini-Zuma and Cyril Ramaphosa believe they have the lead. The market is pricing in a Ramaphosa win in December, with Dlamini-Zuma sitting at 26%, but we think this is an underestimation and can open up the complacency to a shock," TreasuryOne said in a statement on Monday.
"The market should be dominated by the downgrades from Friday, and further weakening is on the cards. The US will resume tax reform talks, but not much is expected from it before the end of the year. The data calendar is light today, so the negative sentiment towards the rand will dominate. We suspect a bias to weaken with us heading towards R14.25/dollar today."

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