Analysis: Weakening rand raises spectre of foreign sell-off of local bonds

Robert Brand

South African bonds face the risk of a sell-off by foreign investors as the rand’s plunge dims the allure of the debt, according to Société Générale (SocGen).

The rand’s 7.8 percent fall against the dollar this year is the worst of 25 emerging market currencies monitored by Bloomberg. South African 10-year yields have risen 12 basis points this month, compared with a 13 basis point drop for similarly rated Mexico.

Risks for foreign investors have increased as South Africa posted a current account deficit close to a four-year high in the fourth quarter after mining strikes and slower growth in Europe cut exports.

A widening shortfall requires more foreign inflows to fund imports, a source of funds that has dwindled after record purchases last year.

“There is trouble brewing in South African markets,” Benoit Anne, the London-based head of emerging markets strategy at SocGen, said on Monday. “We may be getting closer to a real-money investor capitulation, the market equivalent of a volcano eruption.”

SocGen is underweight on South African bonds in its emerging market optimal local bond portfolio. The nation’s debt of all maturities longer than one year has lost 7.4 percent for dollar investors this year, the third worst, after Japan and the UK among 26 sovereign markets tracked by the European Federation of Financial Analysts Societies and Bloomberg.

Yields on government bonds due in February 2023 were at 6.84 percent yesterday morning. The yield may rise to 6.97 percent by year-end, according to estimates by five analysts.

Foreign investors have been net buyers of R13.5 billion of local bonds this year, or an average of R1.2bn a week, compared with average weekly purchases of R1.8bn last year, according to calculations based on data from the JSE.

The current account gap reached 6.5 percent of gross domestic product in the fourth quarter of last year, down from a revised 6.8 percent in the third quarter, which was the biggest shortfall since the same period in 2008, the Reserve Bank said last week.

The country’s relatively high interest rates might continue to attract foreign investors to the nation’s bonds, supporting a rand recovery, Bruce Donald, a currency strategist at Standard Bank, said in a note on Monday.

The current account gap might narrow as the weaker rand boosted the competitiveness of exports, he said.

The Reserve Bank will leave its repo rate unchanged at 5 percent today, maintaining the rand’s yield advantage over the dollar, according to all 12 economists in a survey. The premium investors receive for holding South African 10-year debt rather than US treasuries has climbed 7 basis points this month to 489 basis points.

The rand weakened 9.38c to be bid at R9.2563 a dollar at 5pm yesterday.

The risk of forced blackouts by Eskom might weaken the rand to R9.95 to the dollar, Peter Attard Montalto, an economist at Nomura International, said in a note on Monday.

The currency also faced threats from labour disputes, a widening budget shortfall and a potential credit-rating downgrade, he said.

The rand fell 15 percent against the dollar in the first quarter of 2008, when coal shortages and maintenance at power plants forced Eskom to cut electricity to mines.

The credit outlook was kept at negative by Standard & Poor’s (S&P) on March 13. Fitch Ratings cut the debt rating one level to BBB in January, following downgrades by Moody’s Investors Service and S&P last year.

“General fiscal worries should continue to combine with growth and balance-of-payments worries to be a key and ongoing market driver,” Montalto wrote. “Our view of weakness from here is still intact.”

The cost to protect South African dollar-denominated sovereign debt against non-payment for five years using credit default swaps has jumped 28 basis points this year to 171. The price of the swaps increases when risk perception deteriorates.

“While the rand has sold off aggressively for a while, so far local rates have generally lagged,” SocGen’s Anne said. “Bond selling has been fairly contained. This may change as stress continues to build up in the foreign exchange market.” – Bloomberg