FxWirePro: Rescue Rand from recessionary risks – USD/ZAR hedging perspectives

The South African economy contracted for the second consecutive quarter, a development that came as a surprise. That means that technically the country is in recession. 

In Q2 overall economic output on a seasonally adjusted basis recorded a 0.2% fall. 

Moreover, the previous quarter’s result was adjusted to the downside to now -0.7% qoq. That means that the economy has grown by only 0.4% compared with the same period last year. Decisive for the weak result was the agricultural sector once again. The economic output of the sector fell by approx. 8% (on a seasonally adjusted basis) whereas in Q1 it had been just below -10%. The contribution from transport and communications was also negative (-1.3%). 

The growth drivers, amongst them mining (1.2%), construction (0.6%), electricity generation and the financial sector (both 0.5%), were unable to make up for this. In view of the weak first half of the year we will adjust our growth outlook for South Africa for 2018 and 2019 to the downside. 

In view of several EM crisis areas the rand is under depreciation pressure as a result of contagion risks. The weak data yesterday has further fuelled these concerns. 

Moreover, the climate for EM countries has cooled considerably. In view of several EM crisis areas markets are focussing on the risks. This is putting pressure on the rand, as the weak economy is susceptible to contagion. 

We have lowered our growth outlook and adjusted our exchange rate forecasts. We assume though that the credibility of the stability orientated central bank, who has already signalled its willingness to act, will contain the depreciation of the rand. 

However, we assume that the credibility of the stability orientated central bank, who already signalled its willingness to act, will mean that rand depreciation will be limited. 

On arisk-reward score card, ZAR screens poorly, with the least amount of reward for the risks taken. Traditionally, this net score has correlated well with subsequent FX return, pointing to further ZAR weakness. South African currency is still modestly overvalued. South Africa is relatively highly exposed to further escalation of US protectionist measures. Its main commodity export, platinum, is very much linked to the auto sector, and in general, its commodity exports rely on China’s and global growth. At the same time, even despite recent FX weakness, the currency continues to screen somewhat overvalued in our FV models. In fact, it’s the only currency within EMEA EM to do so. Courtesy: Commerzbank

Trade tips: Buy 06-Dec-18 USDZAR call (14.50), spot reference: 15.4907 levels.

Currency Strength Index: FxWirePro's hourly USD spot index is flashing at -24 levels (which is mildly bearish), while articulating at (14:09 GMT). For more details on the index, please refer below weblink:

http://www.fxwirepro.com/currencyindex