South Africa’s credit rating cut further into ‘junk’
The South African rand took a hit on Friday following the downgrade of the country’s credit rating. Standard & Poor’s lowered further the long-term foreign currency sovereign rating into ‘junk’ territory, to ‘BB’ from ‘BB+’. The rating agency also slashed the country’s local currency investment grade as it lowered the rating to ‘BB+’ from ‘BBB-‘. In addition, Moody’s placed the Baa3 rating on review for downgrade. According to Moody’s, ‘The decision to place the rating on review for downgrade was prompted by a series of recent developments which suggest that South Africa’s economic and fiscal challenges are more pronounced’.
USD/ZAR rose almost 2.60% in a matter of minutes and hit 14.4656 before the closing bell. However, the currency pair reversed losses on Monday morning, with USD/ZAR easing to 13.90. South Africa’s sovereign yields barely reacted to the news with both the 2-year and 10-year yields rising only 6bps. The lack of reaction from investors suggests that the downgrade doesn’t change anything right now. Given that the country had already been stripped of its investment grade rating in April this year. However, it still sends a negative signal to investors and acts as another warning for the country. Indeed, little has changed since the last credit rating cut: the growth prospects remain weak and the debt burden keeps increasing. A downgrade to junk by Moody’s would exclude South Africa from the World Government Bond index, which will eventually add further pressure on bonds’ price. We expect further weakness in the rand as the government will likely takes its time to come with a clear plan. USD/ZAR should continue moving towards 14.75.
EUR/USD: Markets cautious with the Fed strategy
The Euro-dollar is back to two-month high despite the fact that the Fed will almost certainly raise rates in December. The pair is now trading above 1.19 dollar for one single euro coin. The ongoing political crisis in Germany did not have any impact yet on the single currency. In other words, markets give the sentiment that the economic impact that could stem from a political change in Germany is not relevant at this stage.
Concerning the US bond market, the 2-year US government bond continues to raise and is now at levels unseen since 2009 at 1.75%. However the back-end of the curve remains somewhat flat above 2.25% meaning that the inflation’s expectations are still very low.
In our view we believe that the inflation is underestimated and that the Fed should actually raise rates even higher, but the US central bank is perfectly aware that increasing rates would trigger turmoil in the bond market. This is why we believe that markets are very cautious concerning the dollar. The US monetary policy is likely to be back on the wait-and-see mode in 2018. For the time being, we believe that the Eurodollar has then more room for further appreciation.
