Analysis: Swaps soar on eve of ratings

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BR Rand 18569

Cross-currency basis swaps, used by traders to exchange cash flows in rand for those in dollars, climbed five basis points on Tuesday to 42, the highest level in a month and the most among 18 developed and emerging markets tracked by Bloomberg.

The premium rose even as foreign investors bought R6.5 billion of domestic bonds last week, the most since September. The rand is the worst performer in the past month among emerging market peers, according to Bloomberg data.

While yields among the highest in emerging markets are luring investors to South African debt, the outlook for the rand is less rosy.

The economy contracted in the first quarter for the first time since the 2009 recession as the strike caused platinum production to plunge.

Standard & Poor’s (S&P), which cited weak growth and labour unrest among reasons for maintaining its negative outlook on the debt in December, will announce the result of its sovereign review tomorrow, the same day as Fitch Ratings.

“The prevailing tone is one of apprehension and nervousness,” Mohammed Nalla, the head of strategic research at Nedbank Group, said yesterday. “Carry trade investors are happy to buy the bonds, but they appear to be protecting against some of the currency risk in the swaps market.”

Carry trade refers to when investors sell a currency with a relatively low interest rate and use the funds to purchase higher-yielding assets in a different currency.

South African benchmark bonds due December 2026 had a yield of 8.36 percent on Monday, the sixth-highest among 23 developing nation sovereigns monitored by Bloomberg.

Bond inflows have picked up since the European Central Bank cut its deposit rate to below zero last Thursday, with investors buying the most debt the following day since October 2012.

The rate on cross-currency basis swaps is still lower than the year’s high of 53 reached on January 29.

“While the local business mood may be bleak, and views on the currency even worse, we would still be cautious about pushing rand weakness too far, too fast,” John Cairns, the head of foreign exchange strategy at Rand Merchant Bank in Johannesburg, said in a client note yesterday. “Certainly, foreign investors aren’t panicking.”

Investors use foreign exchange swaps and basis swaps to hedge against currency declines that would erode returns. Foreign exchange swaps are typically for less than one year, while cross-currency basis swaps usually range from one year to 30 years.

The latter are agreements in which a person borrows in one currency and simultaneously lends in another. The trade involves the exchange of two different floating-rate payments, each in a separate currency.

The rand weakened 0.5 percent early yesterday, in a third day of declines, as central bank governor Gill Marcus expressed “concern” about second-quarter growth and government-brokered talks to end the platinum strike failed. Yields on December 2026 bonds rose 0.08 percentage point to 8.45 percent.

S&P would probably lower the local currency rating to BBB+ from A-, and there was a “better-than-50 percent” chance of a foreign currency rating cut to BBB-, the lowest investment grade category, Standard Bank said on Friday. Fitch might change its outlook to negative from stable, while maintaining its BBB rating, on par with Iceland and Bahrain, it said.

Nalla said most of the negativity was already priced in and “long-term flows will depend on global factors”. – Bloomberg


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