The rand has surprised almost everyone thanks to a 19% rally over the past six months that has propelled it to the best-performing emerging market currency against the dollar over that period. Now, one local asset manager says the currency’s bull run has further to go.
Cape Town-based Prescient Investment Management, which oversees R102bn in assets, says the rand is “structurally undervalued” and will rally further as SA’s comparatively high yields attract investors from markets such as the US and UK where yields are close to zero.
Prescient is also “very positive” on SA bonds and has a “strong overweight” position in the securities, which it believes will also benefit from a global hunt for yield.
While Prescient declined to provide a specific rand forecast, it said it expects “quite a bit of more strengthening”.
At a current exchange rate of R14.45/$ the currency is already 45c stronger than Bloomberg’s R14.90/$ median fourth quarter forecast of 39 international analysts polled in February.
“We’re seeing negative real yields around the world and a very pronounced hunt for yield — that makes the carry trade very attractive,” says Bastian Teichgreeber, chief investment officer at Prescient. “We do see the currency as structurally undervalued — that does mean we expect quite a bit of more strengthening. On SA bonds we are very positive. We are strong overweight there.”
Unprecedented monetary stimulus due to the Covid-19 pandemic has caused foreign investors to return to the local bond market, buying a net R12.8bn of SA government debt so far this year after they dumped almost R40bn of the securities in 2020. That has helped narrow the spread between shorter and longer-dated debt, suggesting investors are feeling more confident about lending to the government for longer periods.
Yield spreads
The yield spread between the R186 bond due in December 2026 and the R2048 due in February 2048 was at 368 basis points on Tuesday, down from 467 basis points as recently as November. Yet that is still significantly higher than the low of just more than 59 basis points reached in September 2016.
“There is a lot of risk premium that still has to compress,” said Teichgreeber. “We think there’s a lot of bad news in the price, and yield spreads are still too wide.”
A major concern for local and international investors has been SA’s growing debt burden, which has caused the country’s debt-to-GDP ratio to widen to 81.8%, up from 63.3% in 2019/2020. While finance minister Tito Mboweni has said he plans to stabilise SA’s debt at about 95% of GDP by 2025/2026, Moody’s said last week that debt could reach 100.7% of GDP by the 2022/2023 fiscal year.
“We are definitely concerned and one has to monitor the situation closely but we mostly have the probability of a default off the table,” said Teichgreeber. “I don’t think we will see a hard default.”
While Teichgreeber said a “soft default”, in which the government prints money to deliberately inflate its way out of a potential debt crisis, is not out of the question, he believes this option is “unnecessary”.
“It’s not so much the local factors that make us positive,” he said. “Locally we do think there is a lot of negative news, but a lot of that is in the price already. What really makes us positive on the rand is more the global factors. Naturally the global factors are the stronger force.”
Prescient is not the only money manager that is optimistic about SA’s bonds. Gryphon Asset Management, a boutique investment house that oversees about R3.44bn, said this week it has allocated 70% of the assets of its two flagship multiasset funds — the Gryphon Flexible and Gryphon Prudential funds — to SA government bonds. Gryphon also discounted concerns about possible rand weakness saying SA’s yield advantage over developed markets will maintain foreign appetite for local debt and support the local currency.
The 8.65% yield offered by SA’s 2030 government bond compares with 10-year US treasury yields of just 1.26%, while 10-year UK gilts yield just 0.6%. With US and UK inflation at 1.4% and 0.6% respectively, both countries thus offer virtually negative real yields.
Teichgreeber said this yield advantage makes the rand one of the world’s most attractive carry trade opportunities. Bloomberg data shows the rand offered the second-best carry return against the dollar over the past six months at 22.1%. Only the Argentine peso offered a better carry return at 22.9%.
“The rand offers one of the most attractive carry trade opportunities because the currency is so liquid,” said Teichgreeber.
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