The South African rand and government bonds jumped on Monday after ratings agency Moody’s kept the country’s last investment-grade credit rating intact, but many investors expected the rally could fade soon.
Moody’s decision on Friday to leave South Africa’s sovereign debt at Baa3, the lowest rung of investment grade, was a relief to beleaguered President Cyril Ramaphosa, who is battling to stimulate growth in Africa’s most advanced economy.
But by revising the outlook on that rating from stable to negative, Moody’s sent a warning that a downgrade could follow in the next 12-18 months – or sooner if the government doesn’t come up with a credible budget in February.
A downgrade to “junk” status on the local-currency rating could trigger large outflows from South African government bonds, as they would be ejected from the benchmark World Government Bond Index.
At 1500 GMT, the rand traded at 14.80 versus the U.S. dollar, around 1.5% stronger than its previous close.
South Africa’s dollar-denominated sovereign bonds surged, with longer-dated issues adding as much as 1.3 cents in the dollar. The yield on the benchmark 2026 rand bond fell 17 basis points to 8.405%, while the Johannesburg Stock Exchange’s Top-40 Index saw modest gains of around 0.5%.
Traders and fund managers expected gains could probably be short-lived, as it would be hard for Finance Minister Tito Mboweni to present a greatly improved fiscal picture in February.
Warrick Butler, executive for rand and emerging market spot trading at Standard Bank, said the three to four months until the February budget was “a very short period of time to pump the water from the Titanic”.
Part of the reason for Monday’s rally was that South Africa had escaped with the best of the possible outcomes from Moody’s, said Wayne McCurrie at FNB Wealth and Investments.
A small minority had thought the rating would be downgraded or Moody’s would place South Africa “on watch” – both bleaker outcomes than a negative outlook.
A healthy appetite for high-yielding assets in emerging markets more broadly and last week’s steep sell-off in South Africa underpinned the rally.
On Wednesday, the rand saw its largest daily fall in over a year, after Mboweni’s medium-term budget slashed this year’s growth forecast to 0.5% and showed government debt racing to exceed 70% of gross domestic product by 2023.
DON’T GET ‘FOOLED’
Deutsche Bank analysts warned clients not to be “fooled” by Monday’s strong gains, adding they were extremely cautious on local government debt and predicted the rand could sink to 15.50 to the dollar, more than 4% weaker than its current level.
Those bearish projections – echoed by some local analysts – come at a bad time for Ramaphosa, who is hosting a summit in Johannesburg this week to try to woo foreign investors.
Adrian Saville, chief executive of Cannon Asset Managers, said the fact that South African credit spreads traded in line with some junk-rated sovereigns showed the bond market had made up its mind.
Despite positive changes to governance at state firms and greater certainty on energy policy, Ramaphosa’s reforms were moving at a “glacial pace,” Saville said.
Investors want to see progress cutting a bloated public-sector wage bill and rescuing state power utility Eskom from crisis.
But those who are more risk-averse have been jettisoning South African bonds for years on the expectation the country would be cut to junk.
Bank of America Merrill Lynch’s David Hauner estimates investment grade-only investors now hold around $1.5-$2 billion of South African local-currency bonds, down from $10 billion three years ago.
(Additional reporting by Marc Jones and Naledi Mashishi; Editing by Catherine Evans, William Maclean)