This analysis was released Monday afternoon, after USD/ZAR had hit 15.70 briefly that morning, because of contagion risks from Turkey’s currency crisis.

The rand has been relatively badly hit. Since last Monday, the rand has lost 7.5%. This makes it the worst-performing currency after the Turkish lira itself (23%). While the rand is usually one of the worst-hit currencies in such periods of risk-off, its weakness still seems out of line with those of other EM risk currencies. 

For example, over the same period, the Argentinian peso has lost 5.4%, the Mexican peso 3.75%, and the Brazilian real – which often competes with the rand as the world’s most risk-sensitive currency – only 2.3%. The underperformance must/will be attributed to local issues, but while there are enough problems to which to allude, the rand weakness does feel overdone.

This morning’s (Monday) initial rand weakness came in very early Asian trade – at around 01:30 SA time, when liquidity would have been extremely thin. As such, these moves do not represent a fair assessment of where the rand should be trading. Note that Asian trade has often seen very sharp rand overreaction. Think Nenegate, when much was made about a brief rand spike to 17.80 in January 2016.

The rand’s movements will be influenced by further bouts of risk aversion caused by Turkey. Action by the Turkish authorities to try and stabilise the lira has become an important issue to watch. The steps that they have taken since Friday stabilised the lira this morning. However, the Turkish authorities have reportedly shown themselves unwilling to take the tough medicine needed (most importantly, rate hikes) to fundamentally turn the market around, with repeated past attempts to stabilise the lira having never helped for any length of time. 
Foreigners have again become huge sellers of rand bonds, dropping R5.2bn on Friday. 

They are likely to be net sellers again today. Such large sales are equivalent to worst days of selling in May and June: interestingly the rand managed to hold up during May but eventually, the extent of the selling started to weigh heavily in June.

The rand weakness implies that it has pushed weaker than its long-term PPP fair-value level. However, interestingly and importantly, rand undervaluation on the PPP valuation implies that it is now close to the values of other high-risk currencies measured on the same basis – i.e. the rand outperformance in the early part of the year has been worked away.

The rand’s Ramaphoria honeymoon is over. Current nominal levels on the rand are similar to those seen before December’s ANC National Conference; while, as noted, the rand is again trading as a high beta (risk-sensitive) currency – a contrast to early this year.

The rand’s weakness will be inflationary – but is unlikely to force the SARB to hike. There are, however, some risks to hikes.  Our view is based on our expectation that because nothing has fundamentally changed globally or locally the rand will retrace its sell-off. 

We are also of the view that unlike the Central Bank of Turkey, the SARB has hard-won credibility, which limits the extent to which sell-offs in the currency are sustained - unless they are fundamentally driven. However, if the USD/ZAR did spiral out of control again this week, and it remained closer to 15.00 we expect the SARB would eventually be forced to take some action. However, we think this is unlikely.

Implied (expected) rand volatility has jumped following the weakness. The rand is now pricing extreme short-term volatility and higher-than-normal volatility over the next few months and even the next year (three-month volatility is at 22% as against the long-term average of around 16%). Meanwhile, that the sharp rise in rand risk reversals (three-month 25-delta) has, from under 3% a week ago, gone to almost 5%, shows the market is now pricing that there is a much stronger probability of sharp rand weakness rather than sharp rand strength.

Looking ahead, from a short-term perspective, the key question is whether current contagion becomes self-fulfilling, with fear generating more fear and further self-offs to an extent that weakness in a much broad enough basket of risk assets starts to affect the real economy. 

We believe that this is unlikely.

From a longer-term perspective, the question is: why did the Turkish Lira react so violently to Trump’s tariff threats? Put differently, is Turkey a leading indicator of underlying structural problems with the global economy? 

There is a risk that Turkey is a symptom of global imbalances built up over a decade of abnormally low interest rates and QE. 

Turkey has taken on large amounts of external debt at low interest rates and with the Fed hiking and liquidity tightening, markets are concerned that its debt burden may not be sustainable, especially if the country’s growth outlook is constrained. 

The question closer to home is the extent to which this applies to South Africa. 

For now, the RMB research team’s initial take is that there is no need to change their view that the majority of trade for the rest of this year will be concentrated in the 13.00-14.00 range, i.e. that the rand will pull back 

John Cairns and Kim Silberman are with RMB

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