Market News 30 October 2020
What we know
This past week was a roller coaster for the rand as a plethora of fundamental factors were revealed. We saw broad-based risk aversion across multiple South African assets as investors reacted to the pandemic edition of South Africa’s budget, with price swings effectively illustrating mixed reviews of Finance Minister Tito Mboweni’s latest update.
With government debt remaining elevated and economic growth remaining subdued, the market demonstrated scepticism of the minister’s optimism and the “green shoots” he purports to be witnessing in the economy. While some good news about sourcing electricity supply from suppliers other than Eskom was reiterated, the R10.5bn allocation to SAA was widely frowned upon. Despite the fiscal adjustment being less aggressive than anticipated, most feel the latest forecasts are realistic and consolidation targets feasible even if execution risks remain very high.
Much of the planned expenditure reduction is intended to come through below-inflation pay increases for public sector workers with which the government has a 2018 agreement that affords protection to their pay packets.
The latest budget has however taken a much more significant step than has occurred in the two earlier this year (and those over the past decade) by focusing heavily on expenditure cuts, and the correct methodologies to raise economic growth and so repair its finances over the long haul. We think the rating agencies may avoid downgrading SA by two notches at their country reviews on 20th November this year, but not enough has been done overall to comfortably avoid a one notch downgrade, especially as both Moody’s and Fitch already have SA on a negative outlook.
All eyes on Election
It’s remarkable to think that in a little over a week we may be done with the 2020 election. But, then again, we might not even have final results for a week or more after polls close; and given how turbulent 2020 has been, it’s probably wise not to bank too heavily on what ‘should’ happen actually taking place.
One thing that has been very clear in the run-up to the election is the USDZAR’s bearish backdrop, which has been in-place since March of this year. It seems as though the prevailing thought is regardless who wins the election, US Dollar weakness is on the horizon as either scenario will do little to change the trajectory at the Fed – or the need for stimulus.
Second wave lockdowns loom
Given the sell-off in equities towards the end of last week, it is obvious that there has been a pick-up in risk aversion. And it would be simple to look at the calendar and pin that all on the election. But, there’s little change there: most polls are sitting very close to where they were a week or two weeks ago; and the more likely factor creating the shift are the surprising COVID-19 numbers that continue to show growth globally, both in new cases and hospitalizations.
Increasing COVID-19 cases continue to persist across Europe, Russia and the United States, leading to revised lockdown measures in various countries. This was clearly represented in a choppy week for the Rand against the EUR, GBP, and USD with price swings of roughly 40 cents (ZAR). Despite a poorly received MTBPS and the global pandemic, the Rand has remained resolute with sustained appetite for risk which remains within the USD/ZAR multi-month downward trajectory.
What others say
Financial Times – Long-term forces stack up against the dollar
“Renewed dollar weakness may well follow given the challenges facing the US economy, even in the wake of its record rebound in growth in the third quarter. Some economists believe a return to pre-pandemic US output does not beckon until late 2021. With rising coronavirus cases hitting an embattled service sector and employment prospects, the urgency of additional stimulus looms in the wake of next week’s US Presidential and Congressional elections.”
IOL – MTBPS: Tito Mboweni laid bare SA’s economic woes but offered little in the way of solutions
“In his Medium-Term Budget Policy Statement on Wednesday, Mboweni signalled that if debt does not stabilise at 95% of GDP in five years, the country’s economic woes will further deepen. Last year Mboweni said it was acceptable if debt was below 30% of GDP, but once it reached 50% it was a crisis. On Wednesday, he said that debt would grow from R3.9 trillion to R5.5 trillion in the next five years.”
WashingtonPost – New pandemic lockdowns in England as restrictions return across Europe
“Looking ahead, he acknowledged that “Christmas is going to be different this year, maybe very different.”
Starting on Thursday, and until Dec. 2, all nonessential shops, pubs, cafes, restaurants, and gyms in England have been ordered to close. Grocery stores, child-care facilities, schools, colleges, and universities will remain open. Those who can work from home were urged to do so, and Johnson stressed that those older than 60 should not go to work if possible. The restrictions were announced for England. The other parts of the United Kingdom — Wales, Scotland, and Northern Ireland — will pursue their own versions of lockdowns, some of which have already begun.“
Globalnews – U.S. election: What happens if there’s a contested election?
“The U.S. Election Assistance Commission says millions more have been voting by mail this year compared to the total for the 2016 election, but this surge in mail-in ballots may mean this year’s election could take weeks to finalise. Beyond the usual calls for recounts, if either candidate is unhappy with the results, there are a couple of ways of trying to change them.”
What we think
As mentioned in our previous commentary “…we struggle to see the case for further ZAR gains, unless of course the USD itself continues to weaken more broadly.”
Our view is that this sentiment sustains going into a period of higher expected volatility and possible uncertainty of announcements. The next few days or weeks could potentially lead to investors shying away from high beta assets such as the Rand in favour of safe havens. This is obviously yet to be decided and largely dependent on outcomes this week. Local news and announcements will probably remain underrepresented with systemic US fundamental factors sure to remain at the forefront of price action.
Given current uncertainty, the below elaborates how we’re currently choosing to assess the situation with respect to the Rand:
Relative to the ZAR performance this year we make two points:
– We’re currently 1.5% off the best levels the ZAR has seen since the pandemic started. If we look to the start of the year when we were trading around 14.80, we are currently trading 10% weaker. Given the current state of our finances and the world, we don’t feel that such a premium for ZAR.USD is unpalatable in the medium-term
– Since the pandemic started, we are traded less than 2% above our best levels, meaning that in the short-term current rates are attractive compared to most periods over the past 6 months
– The US elections and how the market reacts thereafter are a major uncertainty and risk (either positive or negative) to ZAR forecasts, meaning hedging one’s bets around this event would be prudent
– Domestic downside risk presents itself fairly early in the year with February’s budget. While we don’t necessarily expect a particularly bad budget (relative to expectations and given everyone is aware of the significant challenges we face), it’s hard to foresee positive surprises creating a catalyst for further ZAR strength
– On the positive side, many economists point to a Rand fair value of 15.50. If this were to be achieved it points to 5% upside
While we’re not necessarily bearish, we feel that a recovery back to pre-covid levels would require at least a couple of years of strong economic growth and policy reform (the caveat being that if the USD suffered a sharp sell-off the Rand would by default strengthen against it).
With all of the above considered, we have to think that clients who don’t have a strong bullish view on the Rand, should be externalising at least 25%-50% of their earmarked funds, if not all, at current levels.
Have a great week ahead!