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Japanese Traders Lead Exit From South African Rand Market

Japanese Traders Lead Exit From South African Rand Market

Trading providers at U.K.-based IG said Monday’s sudden collapse in the South African rand was due to low volumes and the decision by a Japanese bank to shed some of its rand exposure, analyst Joaquin Monfort said in a report in PoundSterling.

According to a note from Barclays, “In the early hours of Monday morning during illiquid trading conditions, the ZAR weakened sharply (9 percent) to a new all-time low of 17.91 per USD as yield-hungry Japanese retail investors decided to cut their ZAR positions.”

“I’m being told by a bank that this has been driven by a liquidation of ZAR by Japan,” said Chris Weston at IG.

The rand is down about 7 percent against the dollar so far this year. After its fall to 17.91 in Asian trading, it recovered to around 16.5 Monday, Barrons reported.

South Africa’s currency may have been crushed by politics, according to a Barrons’ blog.

The sudden reshuffling in South Africa’s finance ministry weakened one of the country’s key macroeconomic institutions and continues to undermine market confidence in the ANC-led government, despite the Dec. 13 redeployment of Pravin Gordhan to head South Africa’s National Treasury, said Mark Rosenberg, a strategist at London-based research consultancy Capital Economics.

Poor confidence continues, “given South Africa’s deteriorating micro-economic and investment policies, as well as negative external headwinds from a slowing China and higher U.S. interest rates,” Rosenberg said in the Barrons blog.

The Japanese bank did nothing wrong – instead it appears the South African rand market is not working as it should, PoundSterling reported. Any unusual move in the market is exacerbated when volumes are thin. The price typically moves further than if there had been more participants in the market.

“Local markets are still trying to absorb what is now being called the ‘flash crash’ – yesterday morning’s extreme moves in the rand – the second in four months,” said John Cairns of RMB Bank, PoundSterling reported. “Market sentiment has been one of shock and this seems to have filtered into thin trade and we all wait and see where things are going.”

“Exaggerated moves match those back in August when USD/ZAR hit 14.00 for the first time this cycle, driven reportedly by some computer trades early in the morning,” Cairns said. “The South African Reserve Bank responded to those moves with a statement suggesting they were prepared to stabilize the market. It will be interesting to see what they do this time around.”

If the recent declines were technical in nature shouldn’t the currency should recover?

Not necessarily so.

“Given that yesterday’s moves were clearly abnormal, a case could be made that the rand should go back to where it started. This seems unlikely. Sentiment, already so poor, has been hit hard and it seems the rand will hold on to at least 3 percent losses.”

Flash crash or not, the rand is vulnerable, Monfort said.

“The South Africa Reserve Bank retains the political and institutional independence to continue to hike interest rates in response to ZAR weakness (and inflationary pass through) despite very sluggish growth, high unemployment and upcoming local elections,” Rosenberg said. “If anything, institutional weakness in the treasury will probably drive a more hawkish (South Africa Reserve Bank), which has been engaged in a slow rate hike cycle of three 25 basis points increases since a 50 basis points hike in January 2014. In our view SARB continues to view itself as South Africa’s core institutional bulwark against weak economic governance, and this will influence its policy reaction function.”

Rising inflation and weak fundamentals create a difficult-to-solve conundrum for the South African Reserve Bank.

If it keeps interest rates low, inflation could rise even higher and the rand will continue to devalue. If it raises interest rates to combat inflation it risks stifling growth.

One possibility is that the central bank could intervene directly as several other central banks have done including the European Central Bank, Swiss National Bank and Reserve Bank of New Zealand.

Analysts at Standard Bank predict the Reserve Bank could raise rates by 50 basis points at its next meeting, scheduled for Jan. 28.

In 2001 and 2008, the South African Reserve Bank did some aggressive rate hikes when the rand slid, Standard Bank analysts said.

“It is hard to see the rand pull back on a sustainable basis,” analysts said. “In recent weeks we have seen South Africa’s real effective exchange rate fall sharply to levels last seen in 2001 and 2008.”

If the bank does not move before it’s next meeting, it could be the focus of intense speculation, Monfort said.

The rand’s upward trend is expected to continue.

“The up-trend is solid, except momentum which is overbought, however this can happen for extended periods in up-trend. Ideally traders should wait until momentum moves out of overbought territory before buying again,” Monfort said.