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South Africa Rand to pick up soon as central banks create new money
The South African rand is likely to benefit from the search for yield anticipated in the coming months as a result of central banks creating new money.
That is according to Alexander Forbes’ head economist Isaah Mhlanga, who foresees the local currency gaining some ground after losing almost 30% of its value against the US dollar.
In mid-January 2020, the rand was trading at R14.41 to the dollar. In late April 2020, it was R19 to the dollar. In recent weeks, the rand has been trading at R18.20 to the dollar.
The rand is one of the most traded emerging-market currencies, it has also been among the worst performers within its peer group because of capital flight to safe-haven currencies, such as the dollar, and assets including gold.
In recent months, South Africa’s economy entered into a technical recession, Moody’s Investors Service downgraded the country’s sovereign credit ratings to sub-investment grade – also known as junk – and then came the COVID-19 pandemic.
Those factors partly explain the rand’s recent dismal trajectory.
Factors at play
The Moody’s downgrade meant South Africa lost its last remaining investment grade rating and was forced out of the World Government Bond Index.
An immediate consequence of the exit is that “the foreign investors that have mandates to invest in countries … [with] an investment grade rating are no longer able to invest in South Africa’s bond market.”
“They had to sell their holdings of South African debt at the end of March,” explains Mhlanga in an interview with The Africa Report.
However, that date was postponed to the end of April, when the investors had to liquidate all bond holdings.
- “We saw those bond outflows last year and the first three months of this year. Also, bond yields increased significantly.”
- “The R2030, the 10-year bond maturing in 2030, rose … 300 basis points [in the period] before COVID-19 to when we got downgraded. Even on the short end of the yield curve, the R186, which used to be the 10-year bond, also spiked over a 100 basis points. [That] means the cost for the state to issue debt is high,” according to Mhlanga.
An increase in bond yields is also a reflection there were no buyers in the market. This, in turn, indicated that there was an understanding yields were going to go up. When yields go up, prices fall.
In such a scenario, that means buying bonds whose prices are going to fall. Hence “there was no one wiling to buy South Africa’s bonds,” explains the head economist.
Worst case scenario over
But “… a lot of the bad news is already priced in,” says Mhlanga, referring to South Africa’s bond yields.
He adds: “… The dollar has been strong … because of flight to safety in terms of capital outflows from emerging markets. We have seen central banks across the world respond aggressively by announcing significant bond-buying programmes [and instituting] quantitative easing to support economies.”
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As far as COVID-19 is concerned, once the environment improves, “we will start to see that money created by global central banks looking for better returns,” points out Mhlanga.
Globally, the search for yield usually leads to capital inflows into countries that have higher real interest rates relative to other states.
“In South Africa, we are still in that environment where you can get anywhere north of 5% in real returns from our bond yields. The 10-year bond is still attractive for foreign investors from a return point of view,” adds the economist.
When the environment settles and there is a better understanding of how this coronavirus crisis is going to unfold, the country may be in a position to receive “lots of capital inflows from foreign investors. That would lead to a stronger currency [in] the next couple of months,” says Mhlanga.