Options Traders See Doom for Rand as Analysts Predict ReboundBy
Rand's risk reversal rises to highest since June 2012
Foreign investors sold rand bonds in August, reversing inflows
While analysts forecast the worst may be over for South Africa’s rand, options traders are at their most bearish on the currency in more than three years.
That’s bad news for bonds, according to Investec Asset Management Ltd. Foreign investors, who own about a third of rand-denominated government bonds, sold more of the securities than they bought in August as the currency weakened to a record amid concern slowing growth in China will hold commodity prices down and as the Federal Reserve moves closer to raising interest rates. They may dump more debt if the rand extends declines, eroding investor returns in dollar terms.
“By the time you convert your returns into foreign currency, it’s negative,” said Malcolm Charles, a fixed-income portfolio manager at Investec, which oversees about $118 billion globally. “As long as emerging-market currencies are under pressure, there’s virtually no demand whatsoever” for local-currency debt, he said.
The median forecast of analysts in a Bloomberg survey predicts the rand will strengthen as much as 1.3 percent to end the year at 12.93 per dollar. By contrast, the premium on options contracts to sell the rand over those to buy the currency, known as the 25 Delta risk reversal, climbed to 5.3 percentage points this week, the most since June 2012, indicating that traders see more likelihood the currency will extend its decline.
Foreign investors sold a net 2.9 billion rand ($216 million) of South African bonds in August, partly reversing a net inflow of 6.8 billion rand the previous month, according to Johannesburg Stock Exchange data.
The yield on rand-denominated bonds due Dec. 2026 climbed one basis point to 8.44 percent by 2:17 p.m. on Wednesday in Johannesburg after rising 8 basis points on Tuesday. The yield is heading for 8.8 percent in the next few days, according to Judy Padayachee, an analyst at Barclays Plc’s South African unit.
The rand gained 0.1 percent to 13.4382 per dollar after falling 1.2 percent on Tuesday, adding to August’s 4.5 percent drop. The currency’s relative strength index, a gauge that uses price swings to identify oversold or overbought levels, climbed to the highest in three years today, suggesting the rand is due for a rebound.
“There may still be more downside for the rand once the Fed starts to hike interest rates,” Mohammed Nalla, head of strategic research at Nedbank Group Ltd. in Johannesburg, said in a report on Tuesday. Rising rand volatility signifies “heightened caution” among investors, he said.
Demand at a weekly government auction of rand debt fell to the lowest in more than a month on Tuesday. Investors ordered 2.3 times the amount offered, compared with an average bid-to-cover ratio of 3.2 percent in four auctions in August, according to data compiled by Bloomberg.
With the economy contracting in the second quarter, weighed down by electricity shortages, South African yields may need to rise more to compensate investors for the added risk, said Investec’s Charles, who recommends holding cash and buying South African debt once yields on the December 2026 bonds get near 9 percent.
“There’s no reason to get warm and woolly about the South African bond market just yet,” he said. “You don’t touch emerging markets because the currency kills you. You sit in cash.”
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