These are fraught times for South Africans. The Public Protector has attacked the constitutional protection provided to the Reserve Bank and the inflation targeting mandate prescribed for it by the Treasury. The (false) notion of white monopoly capital – introduced to counter the critics of state capture – has become a constant refrain and irritant to white South Africans who play such a crucial role in our economy. The tale of corruption at the highest levels of the state is being continuously reinforced by extraordinary revelations out of cyberspace.
They further drain the confidence of businesses and households, whose reluctance to spend has led the economy into recession. The election of a new head of the ANC and presumptive President is being be contested on the issue of corruption and who bears the responsibility for it.
The ANC is currently debating economic policy. Appointed economic commissions have debated the issues and will reveal soon just how the governing party’s economic policy intentions have changed.
These uncertainties could be expected to influence the value of the rand and of SA equities and bonds listed on the JSE. Such would appear to be the case with a recently weaker rand and upward pressure on bond yields. JSE-listed equities, when valued in rands rather than US dollars, may behave somewhat differently in response to SA political risks. Given that many of the companies listed on the JSE (with large weights in the calculation of the All Share and other indices) derive much of their revenues and incur much of their costs outside of SA, their rand values tend to benefit from rand weakness, especially when this is associated with additional risks specific to South Africa. There are other risks to the share market that are common to the global economy and emerging markets generally. These forces are likely to effect the US dollar value of these companies, mostly established on offshore stock markets that are then translated into rand values at prevailing exchange rates. Rand strength since mid-2016 has been associated with improved global economic prospects identified by higher commodity and metal prices and increases in the US dollar value of emerging market (EM) equities generally.
It is possible to identify SA-specific risks by observing the performance of the rand relative to other EM currencies. Further evidence can be derived from the spreads between RSA bond yields and the equivalent yields offered by developed market governments and other EM issuers of US dollar-denominated bonds. We provide such evidence in figure 1 below.
It should be appreciated that bond yields in the US and Europe all kicked up very sharply last week (Thursday 29 June) after ECB President Mario Draghi indicated a much more sanguine view of the outlook for growth and inflation in Europe. The prospect of higher policy-determined interest rates accordingly improved, as did the likelihood of an earlier, rather than later, end to quantitative easing (QE) in Europe and its reversal, or tapering. This led to a degree of euro strength and dollar weakness – but as we shall see EM currencies, not only the rand, lost ground to the weaker US dollar. An early hint of US tapering in 2013 had led to US dollar strength and EM currency weakness and the responses in EM bond markets did have a mild hint of these earlier taper tantrums, as we will demonstrated. Better news about US manufacturing this week helped the US dollar recover some of its losses against the euro. Late on Friday (30 June) the euro was trading at 1.1426 – early yesterday (5 July) it was being exchanged at 1.132.
As we show in figure 1, the USD/ZAR exchange rate has moved mostly in line with the EM currency basket since 20121. The rand is well described and explained as an EM currency. As demonstrated by the ratio of the rand to the EM basket, the rand did relatively poorly for much of the period under observation, and especially after the first President Jacob Zuma intervention in the SA Treasury in December 2015. Then the rand, at its worst, weakened by as much as 25% more than had the average EM currency.
However through much of 2016, the rand did significantly better against the US dollar than the EM basket, with the ratio ZAR/EM (1 in 2012) back again to 1 in 2017, indicating less SA-specific risk. However the second Zuma intervention, the sacking of Finance Minister Pravin Gordhan in March 2017, reversed some of this improvement in the relative performance of the rand against other EM peers – but then was followed again by a degree of further rand strength compared to the EM average.
This improvement in the relative value of the rand was interrupted again in modest degree towards 27 June, as we show more clearly in figure 2 below. The ratio of these exchange rates, based as 1 in early 2017, was 1.02 midday on 5 July. However at the time of writing (late 5 July) the rand has weakened further against the US dollar and the other developed market currencies and presumably also against other EM currencies.
The impact of the most recent news flow, including the news leak on the morning of 5 July that the ANC had called for state ownership of the Reserve Bank, led to about a 1% decline in the rand against other EM currencies by midday yesterday, 5 July. By then the USD/ZAR had weakened from an overnight R13.2 to R13.398, with more weakness following. The EM currency basket had also weakened that morning of 5 July but by only about 0.42% against the US dollar. It should be recognised that much, of the rand weakness in 2017was caused by global forces reflected widely in the EM financial markets.
We await further news about the resolutions adopted by the ANC gathering and pointers to the election of a new ANC leader. The interpretation of these political developments will reveal themselves in the financial markets in the same direction as they have to date. The change in ownership of the Reserve Bank is symbolic and without operational substance. The operations of the Bank are determined entirely by the executive directors and managers who are appointed by the State. The 600 private shareholders (of whom I happen to be one with 100 shares), receive a constant predetermined 4% annual dividend and have the right only to appoint seven of the central bank’s 10 non-executive directors and to attend the AGM. But as we have noticed, symbols have significance and do point to the future direction of economic policy. Any threat to Reserve Bank independence or to fiscal conservatism is a threat to the rand and to the bond market, but less, as we point out below, to the rand value of the equity market.
When we turn to the bond markets a similar picture emerges: a modest increase in the SA risk premiums in late June and early July. Long term interest rates have all moved higher in response to the words of central bankers in Europe. However the spread between RSA yields and US yields has not widened materially, perhaps by only 8 basis points.
This spread incidentally is now as low as it was in early 2015, despite the downgrading of RSA debt by the rating agencies. It may be concluded from these generally favourable developments in the currency and bond markets, that the market is discounting the threat to SA’s economic policy settings posed by President Zuma. The market may well have been anticipating the end of the Zuma presidency.
The spread between RSA and other EM bond yields has also been well contained – despite political developments in SA. The five year RSA Yankee bond’s Credit Default Swap (CDS) spread vs the US – very similar to the spread between the RSA Yankee bond yield and the Treasury bond yield – has moved marginally higher. The spread between other high yield EM and RSA CDSs has narrowed marginally, indicating a somewhat less favourable (relative) rating for RSA debt in recent days. RSA CDS swap spreads over US Treasuries are compared below in figure 6 to those applying to dollar denominated bonds issued by Turkey, Brazil and Russia. Little change in EM credit ratings, that is what it costs to insure such debt against default, can be noticed.
JSE-listed equities by contrast have significantly underperformed their EM peers in recent weeks, as may be seen in figure 7 below. The strong rand has been a head wind for the JSE, given the preponderance of companies with offshore exposure and whose US dollar values are determined on offshare markets and translated into rands at prevailing exchange rates. Over the longer run the US dollar value of the JSE and the EM benchmarks track very closely, helped by similar exchange rate trends as well as earnings trends.
The SA economy plays on the JSE have not yet had the benefit of lower interest rates that usually accompany a stronger rand and lower inflation. So what has been a headwind for the rand values of the global plays has not yet turned into a tailwind for the SA economy plays: the retailers, banks and especially the mid- and small-cap counters that have trailed the market in general.
A cyclical recovery of the SA economy cannot occur without reductions in short term interest rates. One can only hope that the Reserve Bank does not wish to assert its independence of politics by further delaying reductions in interest rates. These are urgently called for and have every justification, even given its own very narrowly focused inflation targeting modus operandi, of which incidentally, I have also been highly critical of. 6 July 2017
1 Equally weighted Turkish lira, Russian ruble, Hungarian forint, Brazilian real, Mexican, Chilean and Philippine pesos, Indian rupee and Malaysian ringgit.
*The views expressed in this column are those of the author and may not necessarily represent those of Investec Wealth & Investment