No end in sight yet to a tumultuous year
As SA heads into the home stretch of 2018, the financial markets are unlikely to get any respite from their recent turmoil given the interest rate and political risks that loom in December.
As ever, the key focus will be the interplay between the dollar and US interest rates.
The markets are assigning an 80% probability to a 25 basis point hike at the December 18-19 federal open market committee (FOMC) meeting, in line with the Federal Reserve’s consistent messaging on the need to tighten policy further in the face of robust US growth.
Matrix Fund Managers economist Carmen Nel says whether this will help or hinder emerging-market currencies will depend on the dollar’s reaction to the FOMC statements as well as to any revisions to Fed members’ individual interest rate forecasts.
“There is little reason yet for the Fed to meaningfully change its forecasts, which means that risk assets such as the rand should absorb the December hike reasonably well,” she says.
Absa fixed income and currency strategist Mike Keenan agrees that a hike is expected so would come as little shock to the markets or the rand.
The dollar is already pricing in a lot of good US news. Part of this reflects political and growth risks elsewhere.
“In the eurozone, the Christian Democratic Union will elect a replacement for German Chancellor Angela Merkel, while Italy’s fiscal and political situation remains messy,” says Nel. “Once these issues are resolved, and eurozone data starts surprising to the upside, the euro should recover.”
Historically, the odds favour a rand rally over December and into the new year. This year might be no exception given that the rand is slightly undervalued. If the dollar is peaking, the rand could end the year stronger, Nel believes.
Absa thinks the rand is likely to remain relatively rangebound during December, oscillating between R14/$ and R15/$, despite two major event risks: the FOMC meeting and Fitch Ratings’ pending country review of SA.
Absa’s year-end point forecast remains R14.25/$.
Keenan expects the rand to settle down in the coming weeks, unless there is a significant bout of global risk aversion stemming from a fresh wave of trade tension between the US and China.
A key release will be SA’s third-quarter GDP data, to be published by Stats SA on December 4.
The Reuters consensus is that growth will recover to 1.5% quarter on quarter in Q3 and 2.1% quarter on quarter in Q4.
If a reasonable rebound materialises, this should reduce the risk premium associated with SA’s weak growth performance and entice renewed capital inflows, which would support the rand, says Nel.
But ultimately a strong rand rally will depend on the dollar, given uncertainty around SA’s stance on land expropriation and its commitment to structural reforms and fiscal consolidation, she says. These issues will probably be resolved only after the 2019 elections.
Fitch’s country review is unlikely to have much bearing on the rand or SA’s growth recovery, given that Fitch has already junked SA’s sovereign rating. In June, Fitch retained SA’s ratings on BB+, the top rung of the subinvestment (junk) grade ladder, and affirmed the outlook as “stable”. However, it released a rather ominous ratings update after the medium-term budget in October in which it expressed scepticism that President Cyril Ramaphosa’s growth-enhancing reforms would significantly change SA’s growth trajectory.
Moody’s is the only one of the three main ratings agencies that still has SA rated investment grade. Should Moody’s junk SA’s ratings at its next review in early in 2019, the country’s government bonds would be ejected from the world government bond index, which could precipitate more than R100bn in capital outflows.
This would hammer the rand and business and investor confidence and cause a spike in SA’s borrowing costs. But most economists expect Moody’s to remain off the trigger at least until after the elections.
If growth recovers and the fiscal position improves, even slightly, SA should be able to stave off further downgrades.