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Rand’s Speedy Recovery Rally Caught Some Traders By Surprise

Rand’s Speedy Recovery Rally Caught Some Traders By Surprise

(Bloomberg) -- The rand’s rapid turnaround from April’s record low has already burnt some traders’ fingers. There may be more victims, judging by the discrepancy between forecasts for the currency and its actual level.

TD Securities’ long-dollar-rand trade, opened on May 21 at 17.92 per dollar, was stopped out just eight days later when the currency strengthened below 17.45, handing the position a 2.6% loss. The trade was entered on expectations that easing by the South African Reserve Bank would hurt the attractiveness of the currency - but the opposite happened.

The bearish predictions were not limited to TD. Analysts in a Bloomberg survey see the rand reaching 18.95 per dollar in the second quarter - implying a decline of around 9% from Monday’s level of around 17.36 per dollar. The probability of the rand weakening that much by the end of June is less than 2%, according to Bloomberg’s forecast model based on prices of options to buy and sell the currency.

Rand’s Speedy Recovery Rally Caught Some Traders By Surprise

In the context of rising U.S.-China tensions over security legislation in Hong Kong, along with a deteriorating economic picture in South Africa, the timing of the rand’s rebound “has been a bit surprising,” said Per Hammarlund, chief emerging markets strategist at SEB AB in Stockholm. Still, “given that the rand and most other emerging-market currencies have some way to go before being back at levels from before the Covid-19 outbreak, the rally has enough legs to last through the end of the second quarter,” he said.

The rand strengthened 5.6% in May, it’s first monthly advance this year and the best since January 2019. On the way, it breached two key resistance levels to further gains: the 50-day moving average at around 18.20 and the 23.6% Fibonacci retracement from April’s record low, at 18.04. Next up is the 38.2 retracement at 17.24, and a sustained breach could see the currency heading toward 16.50 per dollar, according to Credit Suisse SA and Standard Bank Group Ltd.

The South African currency started April on the same track, strengthening 1.1% to 17.3609 per dollar by 8:30 a.m. in Johannesburg on Monday.

While a tentative return of risk appetite worldwide contributed to the rand’s advance, the currency also received some support from a relatively hawkish central bank. The regulator on May 21 curbed expectations for further aggressive easing after cutting its benchmark interest rate for the fourth time in as many months in a bid to support an economy forecast to slump deeper into recession.

Also bolstering the currency were signs that record outflows from South Africa’s domestic bond market may be coming to an end. Foreign investors started trickling back into local debt in the second half of May, after selling a net 66 billion rand ($3.8 billion) this year.

Rand’s Speedy Recovery Rally Caught Some Traders By Surprise

After returning 6.2% in May for investors who borrow dollars to buy high-yielding currencies, known as the carry trade, the rand’s one month volatility-adjusted implied yield has climbedto the highest in nearly two months. That suggests more rewards may be in store for investors willing to risk buying one of the emerging world’s most volatile currencies.

Still, there are risks ahead. Rising tensions between the U.S. and China could spill over into emerging-markets, while South Africa’s economy has yet to show the full hit of the coronavirus lockdown.

“The question on most people’s minds at the moment, is what to make of this recovery in the rand and can it be sustained to much stronger levels?” asked Warrick Butler, a Johannesburg-based trader at Standard Bank. “The answer to this is not that straightforward,” though short-term gains are likely to continue, he said.

Still, “there is only so far it can go,” Butler said. “The more the elastic band stretches, the more pain will be felt upon its release.”

©2020 Bloomberg L.P.