In a highly anticipated decision, S&P has elected to affirm South Africa’s credit rating on foreign currency denominated government debt at its current investment grade, just one notch above “junk”. This was considered the less likely option by economists that were surveyed by Bloomberg in November. The ratings agency did, however, cut the rating on South African local currency denominated government debt to two notches above junk.
The reasons cited include:
- Political events transpiring which have been distracting the government from implementing reforms to enhance growth.
- Low growth potentially having adverse consequences on the “public balance sheet”.
The immediate reaction of the currency is shown in the chart below, which displays intraday exchange rates. As at the time of writing, the Rand had gained 1.57% against the Dollar for the day.
This decision comes after last week’s ratings action by Fitch, who also affirmed our foreign currency denominated government debt at investment grade, however they lowered their outlook to “Negative”. S&P’s affirmation today leaves the two agencies with the same rating and outlook. Moody’s did not issue a credit rating action last week, however they did publish a note on South African credit, citing political infighting, lack of structural reforms and protracted low business confidence as threats to the rating.
With S&P affirming the rating on foreign currency debt, South Africa has avoided what looked like the biggest threat to its investment-grade status. However, it has simply bought time until the next round of assessments halfway through next year. If growth, reform and politics do not improve in the next half-year or so, then South Africa will be back where it started - waiting anxiously on the word of international ratings agencies.
In the wake of the largely unexpected election win by Donald Trump, markets have reacted in some interesting ways. The US market reacted initially with a sell-off, but then whip-sawed into a mild relief rally. Treasuries are selling off and yields are rising on the back of what commentators are suggesting is the Trump “regime change”. Why is this happening? Markets are expecting growth and inflation from Trump’s proposed spending plans which would likely be funded by government bond issuance.
Indeed the sell-off is being seen in other markets too, especially emerging market currencies and bonds. (Source for all charts: Bloomberg)
Regarding specific currencies, the drops that have occurred in the Mexican Peso are easily understood: Trump’s rhetoric on the campaign trail was directed at the economic relationship between the US and Mexico, specifically he pledged to repeal NAFTA and renegotiate trade between the nations. But the sharp drops in the Rand are somewhat surprising. Indeed, in the two trading days since the election result was known, the Rand lost 7%. For comparison’s sake, over the same period the JP Morgan Emerging Market Currency Index (pictured above) lost 1.67%.
The market’s reaction is, in our opinion, based on three possible factors:
- Trump’s Trade – Donald Trump campaigned on an anti-trade platform, which would be relatively bad news for trade-intensive emerging markets such as South Africa and could impact other emerging market currencies and assets.
- Investor Uncertainty – With Donald Trump comes a number of questions: Which of his policies will be implemented? To what extent will the rhetoric match reality? This uncertainty tends to create demand for safer assets, reversing portfolio flows into South Africa.
- The Fed – The market has begun to price in inflation again, and this should improve the probability of a rate hike. If markets continue to be optimistic, we think the Fed will more than likely raise rates.
The chart below displays the annualized volatility in the Rand since 2000. Since 2000, this year has been the second most volatile, after 2008.
The chart below compares 1 month at-the-money implied volatilities for the Rand and the Peso (against the Dollar).
With all of the political risk and credit downgrade fears swirling in South Africa this year, these charts could make sense. But it is still a bizarre result, considering the US is Mexico’s biggest trading partner and that they were holding an election, with one candidate from a major party essentially hostile to said trading relationship.