ZAR: Cheap and increasingly cheerful - HSBC

Research Team at HSBC, notes that the ZAR has been the best EM FX performer in the last month, appreciating over 9% versus the USD.

Key Quotes

“But many valuation metrics suggest that the ZAR remains cheap, even after this significant rally. Using a longer time horizon, the ZAR has sold off by 30% in REER terms since 2011. This broader depreciation of the currency overshot the decline in its fundamentals, in our view.

We believe that there is space for the ZAR’s undervaluation to correct further and that USD-ZAR will maintain its recent downward momentum. Part of this comes down to the benign external dynamics – lower developed market rates for longer and subdued FX volatility.

But there have also been some improvements domestically, which can be described as a triptych1 of three panels:

1) Fiscal: The risk of a ratings downgrade triggering large and sudden capital outflows seems low in the coming months. Longer-term challenges have not disappeared but we do not think this will be a pivotal issue for the market until much closer to the next round of reviews, due in December, and a downgrade is not our base case scenario.

2) Monetary: SARB policy will remain a solid anchor. FX implied yields and real rates remain attractive to investors, both in absolute terms and relative to peers.

3) External rebalancing: The trade deficit has started to rebalance and the recent decline in investment income earnings may prove short-lived. The downward trajectory of the current account deficit may therefore be over the worst.

So while longer-term challenges have not disappeared by any means, we see the ZAR’s recent appreciation as part of a normalisation after an excessive decline late in 2015 and at the start of this year. Therefore, we revise our USD-ZAR forecast to 13.0 by year-end vs 16.2 previously. We believe this ZAR appreciation can continue next year and see USD-ZAR at 12.5 by year-end 2017.”