USD/ZAR: Too “strong” to be true - Natixis

Nordine NAAM, Research Analyst at Natixis, notes that since the start of the year, the South African rand has extended its rise against the US dollar and euro to what are its highest levels since 2015.

Key Quotes

“As result, the USD/ZAR pulled back below 13 in February. When it comes to emerging currencies, the South African rand has recorded the second strongest increase, up 6.15% against the US dollar and up 5.14% against the euro since the start of the year. Despite this flourish, our view is that the South African currency seems fragile and likely to correct in 2017 given the many negative factors, notably at macroeconomic level and, especially, at political level.”

“Expectations are that GDP growth will reach 1.0% in 2017 given the absence of structural reforms. The agricultural sector is the only one expected to see an improvement in 2017, household consumption being penalised by the very high 27% unemployment rate. Inflation is unlikely to pull back inside the central bank’s official range of between 3% and 6% at the end of the year given that crude oil prices are on the rise. Since real rates are near zero, the South African Reserve Bank will not be able to cut its key policy rates, which are likely to be kept on hold. Finally, the government does not have much leeway at fiscal level.”

“Capital outflows accelerated in 2016, with negative investment flows of $8.8bn for the equity market, and there have been further outflows since the start of 2017, totalling $1.3bn.”

“The major risk for financial assets is at political level. With the ANC leadership elections scheduled at the end of December, there is a not insignificant risk that President Zuma will reshuffle the government to foil one of his adversaries, namely Finance Minister Pravin Gordhan, who is very much appreciated by the markets given his determination to press ahead with a fiscal consolidation. Clearly, most credit rating agencies would be likely to downgrade the country’s credit rating if there is a government reshuffle and this threatens to undermine efforts to cut the fiscal deficit. There follows that South Africa is at risk of losing its Investment Grade status. Currently, the country is rated BBB- by S&P, BBB- by Fitch and Baa2- by Moody’s.”

“Besides these country risks, there are risks linked to the appreciation of the US dollar and US long interest rates, which would penalise the South African rand by accelerating capital outflows. This week, Donald Trump’s State of the Union Address could at long last confirm that there will indeed be a fiscal stimulus package. This in turn would be likely to stoke expectations of a rise in the Fed Funds rate and US dollar. After that, there will be the FOMC meeting on 15 March.”

“Despite all these risks, notably at political level, the USD/ZAR could test 12.64 and the EUR/ZAR 12.90 before both pairs going to recover towards 14 in coming months.”