BNY Mellon: ZAR Comes Back Into Focus
BNY Mellon: ZAR Comes Back Into Focus
By Simon Derrick, Chief Currency Strategist
- Gold and ZAR performance historically linked
- Yield support modest when put in context of historical currency moves
- Investors remain cautious about currency
The rise in USD yields in recent days has hit gold hard. This, in turn, suggests that the next place the USD strength could make itself felt is in the commodity currency space. Given that gold, diamonds and platinum (along with other metals and minerals) still represent a significant proportion of South Africa's exports, this brings the focus back onto the ZAR.
Understandably enough, precious metal prices appear to have played a role in driving the performance of the ZAR over the years. The start of the two decade downtrend in gold prices in early 1980 came nine months ahead of the start of the ZAR's own 21-year downtrend, while the final turnaround in the currency's performance at the end of 2001 came just seven months after gold prices finally bottomed out. Similarly, the collapse in the ZAR that began in the summer of 2011 and ended in January 2016 coincided pretty well exactly with the 42% drop in the price of gold against the USD over the same period.
It is therefore unsurprising that periods when the carry trade into the ZAR has proved popular have coincided with periods of stability or strength for gold.
There were three substantial periods (October 2002 to May 2005, July 2009 to September 2011 and January 2016 to April 2018) when the carry trade into the ZAR worked well. The average y/y gain (from currency appreciation and yield pick-up combined) from holding ZAR over the USD over these three periods was 15.59%.
The corollary to this is that during the primary downtrends for the ZAR the USD was gaining an average of 14.7% a year, easily overwhelming the average 665 bp yield advantage seen over these periods of currency weakness.
The yield support for the ZAR against the USD is relatively modest right now, with the one-year interest rate differential over the USD at 489 bps and the two-year and five-year yield gaps between South African and US government paper at 456 bps and 533 bps respectively, standing close to the narrowest level seen in over a decade.
Despite this, volatility in USD/ZAR currently looks unremarkable, with 21-day realized volatility standing at 14.37%, compared to an average level since October 1995 of 16.76%. However, it’s worth recalling that when currency volatility hits the ZAR it can be spectacular.
This is a difficult time for South Africa, having just unveiled the largest bailout in the country’s history for Eskom. As a result this year’s budget deficit is expected to now come in at over 4% of GDP, while state debt as a share of GDP will rise to more than 60%. This bailout, in turn, is already ringing alarm bells among the ratings agencies.
iFlow data suggest that investors have become increasingly cautious about the ZAR since April 2018, with only a modest rebound back into the currency since the start of this year.
The current shift in the supporting dynamics for the currency may therefore bear watching closely.