talking technicals
GARTH MACKENZIE: Rand's resilience amid the rot
The rand’s strength seems to be more a function of foreign factors than local ones
The rand has left many market participants scratching their heads over the past year: as local politics and economics deteriorate, the currency has continued to strengthen. In the second quarter of 2017 it was particularly strong, despite SA being downgraded by all three major ratings agencies during that time.
The reality is that movements in the rand have been influenced far more by global yield differentials than local politics. Political noise has provided only for short-term counter-trend movements in a generally strengthening rand environment. Whenever the flow of effluent from political leaders’ mouths abates, the rand has tended to move stronger, illustrating that something much bigger than political noise has been the major driver behind the rand’s strength.
The answer to what that may be is found in two words: “carry trade”. This refers to borrowing money in developed markets at very low interest rates, and investing those funds in emerging market bonds offering a significantly higher yield. An investor using this strategy simply has to hedge the currency movements and lock in the hefty yield differential. Borrowing rates in markets such as the US, developed Europe and Japan are generally less than 2.5%. In Japan the borrowing rate is close to zero; in the US, the Federal Reserve recently raised rates to 1.25%. Contrast these with the yield that can be attained on a local R186 government bond at about 8.9%, and it’s clear the yield differential is substantial.
Two of three ratings agencies is sufficient to qualify our debt as investment grade on the whole. If, on the other hand, two ratings agencies downgrade SA’s rand-denominated debt to junk status, a huge exodus of foreign “hot money” is expected to flow out of the local bond ...
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