USD/ZAR to return to the 13.31 area in the coming weeks - BBH

"The rand has done well this year after a strong 2016.  In 2016, ZAR rose 13% vs. USD and was behind only the best performers BRL (22%) and RUB (20%)," note BBH analysts.

Key quotes

 So far in 2017, ZAR is up 8% YTD and is behind only the top EM performers KRW (11.5%), MYR (10%), and THB (+9%).  Our EM FX model shows the rand to have VERY WEAK fundamentals, so this year’s outperformance is likely to ebb.  

At the very least, we look for the pair to move back to the 13.31 area in the coming weeks.  Retracement objectives for USD/ZAR from the November-December drop come in near 13.3130 (38%), 13.5540 (50%), and 13.7950 (62%).  Note that the 200-day moving average comes in near 13.3325, so a clean break of the 13.30 area would likely set up a quick test of the 13.5540 level.

South African equities are underperforming EM for the second straight year.  In 2016, MSCI South Africa rose 0.6% vs. 7.3% for MSCI EM.  So far this year, MSCI South Africa is up 17.5% YTD and compares to 32% YTD for MSCI EM.  This underperformance should continue, as our EM Equity model has South Africa at a VERY UNDERWEIGHT position.  

South African bonds have performed OK recently.  The yield on 10-year local currency government bonds is about -22 bp YTD.  This is in the middle of the EM pack.  The worst performers are Czech Republic (+115 bp) and China (+88 bp), while the best are Indonesia (-151 bp) and Hungary (-114 bp).  With inflation likely to continue easing and the central bank posed to restart the easing cycle, we think South African bonds will start outperforming more.  

Our own sovereign ratings model showed South Africa’s implied rating falling a notch this past quarter to BB-/Ba3/BB-.  As such, we believe actual ratings of BB/Baa3/BB+ are seeing even greater downgrade risk.  Finance Minister Gigaba’s October mid-term budget statement did not prevent a S&P downgrade, and its new BB+ local currency rating led to ejection from Barclays Global Aggregate Index.

The loss of investment grade from Moody’s seems likely after the February budget is released.  However, Moody’s have been very patient and may wait to see how the political outlook shapes up before making any moves.  If Moody’s were to downgrade next year as it eventually should, South Africa would be ejected from Citi’s WGBI.