Daily Brief – Pathway from Junk

Pathway from Junk

Emerging markets have been an interesting space to watch in FX. Despite episodes of risk, the carry trade, where investors benefit from exposure to emerging markets funded by cheaper cash in developed markets, has remained immensely popular. Despite the backdrop of declining global bond prices this year making developed market assets more attractive, demand for emerging markets has remained healthy to say the least.

The price adjustment that has now taken place across many emerging markets makes the space even more complicated. With the premium for emerging market currencies now being significantly higher than at the start of the year, the question remains: for how much longer can EM FX continue to attract demand at current prices? In the case of the Rand, perhaps longer than we might have otherwise thought.

Cast your minds back to 2017. The first three months saw a record rally in the Rand versus the Dollar. However, then-President Jacob Zuma’s dismissal of Finance Minister, Pravin Gordhan, reversed the fortunes for the Rand for it to become the worst performing currency amongst the 140 widely tracked in the market as soon as early-April. The shock dismissal turned into a credibility review and ultimate downgrade of the fiscal outlook for South Africa. However, nearly a decade on and thoughts from Goldman Sachs this week suggest that may be all set to change.

Ratings agencies S&P Global and Moody’s both maintain a positive outlook on South Africa, holding the nation two notches below investment grade. If the days really are numbered for South Africa’s classification of ‘junk’ debt, the impacts upon the currency would be huge. Fair value models suggest the Rand could be a lot stronger against the Dollar than its current spot and forward price in the market. One way to easily materialise that foregone value is talk or realisation of a ratings upgrade.

Discussion and Analysis by Charles Porter

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