Why Wheels Are Coming Off The Rally In The Rand

The currency has swung to being the emerging world’s worst performer this month, from best in the third quarter, after a move to prosecute Finance Minister Pravin Gordhan sparked a sell-off of South African assets.

The wheels are coming off the rally in the rand.

Volatility has jumped to the highest among currencies tracked by Bloomberg, catching out investors and driving others to steer clear of South African markets until the political storm has passed.

The roller-coaster ride is testament to the depth of concern among investors over the battle between Gordhan and supporters of President Jacob Zuma for control of the nation’s purse strings. It also highlights the difficulty of assessing political risk in an emerging democracy such as South Africa, with some investors seeing recent events as a tipping point, while others regard them as noise that will blow over.

“The rand today is very, very hard to trade,” said Guillaume Tresca, a Paris-based senior emerging-market strategist at Credit Agricole SA. “On a daily basis, it’s a nightmare. You can have a rally for one or two weeks and it will perform very strongly, and all of a sudden you have a headline on the political risk and you can lose all your money in five minutes.”

In April, as risks to South Africa’s credit ratings rose and Zuma faced an impeachment vote, Credit Agricole forecast that the rand would weaken to beyond R16/$. Instead, it rallied to R13.2/$ in early August.

The rand gained 7.3% against the dollar in the three months ended September, the most among 24 emerging-market currencies. It ended last week 4.2% weaker, lagging behind its developing country peers.

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Foreigners dumped R14.3bn of the country’s bonds and stocks last week amid concern that Gordhan may lose his job. The currency plunged as much as 4.3% on October 11 after he was summoned to court on fraud charges. The next day, it gained as much as 2.5% as the head prosecutor said the charges could be reviewed. Volatility rose to the highest since June.

On Tuesday at 07:00, the rand was trading 1.5% stronger against the dollar at R14.09, leading gains among emerging-market currencies. All emerging-market stock and currencies rose on Tuesday as the dollar dipped after mixed US economic data didn’t bolster the case for the Federal Reserve to raise interest rates this year.

Greatest volatility

The rand is the world’s most-traded currency relative to gross domestic product, according to Renaissance Capital, with global volumes averaging about $51bn every day, figures from the Bank for International Settlements show. Three-month implied volatility for the rand to the dollar, an indication of future price swings options traders expect, is the highest of 29 major and emerging-market currencies monitored by Bloomberg.

Traders paid the highest premium in three months for options contracts to sell the rand over those to buy it on October 11, as Gordhan was served with the summons. The three-month risk-reversal has since retraced to 3.6.

The currency will weaken to R17/$ by year-end after South Africa’s credit rating is cut to junk, said Peter Attard Montalto, an economist at Nomura in London who says markets are under-estimating the political risks that affect the value of South African assets.

“The volatility in forecasts just shows us it’s all ultimately down to personality politics at the end of the day, which is the worst sort and the hardest to factor in and forecast around,” he said. “This is the depth of intrigue and unpredictability, ultimately.”

‘Really hurt’

Not everyone is bearish on the rand or staying on the sidelines. Standard Chartered said last week the “political noise” in South Africa is an opportunity to build “long” rand positions. Societe Generale SA last week upgraded the country’s debt to overweight.

Francois Botha, who helps oversee R15.5bn of assets at Novare Investments in Cape Town, agrees that the rand’s volatility makes it wise to be cautious. Investors who moved funds out of South Africa after Zuma fired Finance Minister Nhlanhla Nene in December “got really hurt,” he said.

“It’s not the best move to react now, now that the currency has already been blown out,” Botha said. “We’re slightly more cautious because we’ve seen since the start of the year how the currency can react and it can appreciate quite a bit, and you don’t want to be caught on the wrong side of that.”

Emerging assets head higher as dollar dips on mixed US data

Emerging-markets were boosted after reports released on Monday showed manufacturing in New York unexpectedly contracted, while factory production across the U.S. grew for the third time in four months.

“The latest economic data from the US has raised more uncertainties about whether the Fed can raise their interest rates this year,” said Andy Ferdinand, head of research at PT Samuel Sekuritas in Jakarta.

“Some people might see this as something positive for emerging-market assets,” he said, adding that he still advised a cautious approach due to risks including the US election and corporate earnings.

The MSCI Emerging Markets Index rose 0.5% to 899.48 as of 00:09 in Hong Kong, with industrial and health-care stocks advancing the most. Celltrion, which produces and sells biosimilar products, led the gauge to jump 5.2% in Seoul.

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