South African Rand’s Recovery Shown in Three Charts
After a rough start to the second half, South Africa’s currency and bonds are primed for a rebound as debt concerns ease and the Federal Reserve signaled a measured approach to tapering.
The rand has topped gains among emerging-market currencies since Aug. 20, when it started to recover from a five-month low against the dollar. The rally was fueled by easing concerns about a pullback in stimulus by the Federal Reserve, a bounce in commodity prices and a data revision showing South Africa’s debt burden is less onerous than previously thought.
The currency strengthened for a seventh day on Tuesday, the longest winning streak since November. These three charts show why it may extend gains in the coming months:
Traders are taking bearish bets off the table after a statistical exercise that boosted South Africa’s gross domestic product by 11% overnight. That means the ratio of debt to GDP is smaller than government projections in February that ratings companies cited as a risk risk to the country’s credit assessment.
Fed Chair Jerome Powell’s cautious tone at Jackson Hole halted a rise in Treasury yields, boosting the attractiveness of higher-yielding currencies including the rand. That’s pushed the premium of options to sell the rand over those to buy it -- known as the 25 Delta risk reversal -- to the least in more than a year.
Foreigners are returning to South Africa’s bond market, made more attractive by the post-Jackson Hole prospect of U.S. yields staying lower for longer. Non-residents were net buyers of South Africa’s government bonds last week after three weeks of net sales, helping to drive the yields on benchmark government bonds to June lows. Even so, the yield pickup on South African rand bonds over U.S. Treasuries remains among the highest in emerging markets.
The bonds should remain bid as the U.S. Treasury yield curve steepens and liquidity improves after the northern hemisphere summer lull, according to Nema Ramkhelawan-Bhana, the head of research at FirstRand Group Ltd.’s Rand Merchant Bank in a note to clients. A “wall of coupon payments” in the second half would also support the bonds as investors reinvest cash, she said.
Implied volatility, which measures expected swings based on the price of options to buy and sell the rand, is dropping and may soon be below actual volatility. The spread between the two is at the lowest since June, suggesting traders expect fluctuations to narrow over the coming months.
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