Global volatility rises on Delta variant woes
Until last month global FX volatility was in the doldrums, so much so that the JP Morgan G7 Currency Volatility Index (a reliable gauge for foreign exchange volatility on a global scale and major developed and emerging market economies, respectively) plummeted to a six-month low. Extremely loose monetary policy has driven the market to extreme levels of complacency and risk-taking behaviour. The coronavirus has changed all that in a flash and likely will for quite some time to come. Even if the virus situation clears up sooner rather than later, the fast pace of the global economic recovery has been dented and points to a period of increased volatility.
Is it a watershed moment for the ZAR?
Against the global backdrop painted above, the tide is beginning to change for the South African Rand (ZAR). This week has seen the local currency come under increased pressure, reminding investors of the risk of holding a high-Beta currency that is at the whim of global dynamics and risk appetite.
As global risk appetite wobbles and political and fiscal risks intensify, the ZAR’s resilience will be tested. Ahead of the upcoming Medium-Term Budget Statement and municipal elections, foreign appetite for local bonds has waned, suggesting that investors are particularly concerned with SA's fiscal and credit risks.
In the third week of September, the ZAR has depreciated more than 3% to sit at above 14.6100 against the USD, its lowest level since August 31, pressured by weak domestic data and a more pessimistic economic outlook for the country. Weak July economic data, meanwhile, has raised concerns about the extent of the impact of the social unrest and tighter lockdown restrictions on South Africa's economy in the third quarter. This is despite President Ramaphosa more recently announcing the relaxation of Covid-19 lockdown restrictions from level 3 to level 2. At the same time, market sentiment continues to be hit by persistent fears of a slowdown in global growth due to the fast-spreading Delta variant and the prospect of an early tapering of Federal Reserve stimulus.
Options market relatively unphased by political noise
While we have seen an uptick in implied USD-BRL volatility in recent days, when pulling back the lens, it is clear that the options market is not overly concerned about the recent wave of political noise. Note that political tensions within the ruling party have intensified in recent days ahead of the upcoming local elections on November 1 due to the candidate saga, which comes on the back of the Zuma arrest and wrapping up of the Zondo commission.
As mentioned in previous commentary, while politics play a role in currency movements, much of the directional stems from underlying macroeconomic fundamentals. There is a host of evidence to suggest that macroeconomic policy is one of the biggest determinants of a currency’s performance, as is the underlying structure of an economy. It is, therefore, apparent that FX and options traders remain focused on the significant improvement in SA’s terms of trade this year and still relatively prudent monetary policy stance of the SARB.
The accompanying chart shows that while implied USD-ZAR volatility has kicked higher in recent days as political and fiscal risks intensify, tenors across the curve remain within the recent trend, albeit it to the upper end. It is also worth flagging that the most notable movements have been in the shorter-dated tenors with the likes of the 1-week and 1-month tenors climbing 2.46ppts and 0.54ppts over the past two sessions to 16.1% and 14.7%, at the time of writing.
Implied USD-ZAR volatility has kicked higher in recent days on the back of the escalation in political noise ahead of the November local elections. However, the movements are relatively insignificant compared to the volatility blowouts seen in response to events such as the COVID-19 outbreak, NDZ vs Ramaphosa Presidential uncertainty and Nene gate, where implied volatility reached levels in excess of 20% and 30%. That said, the ZAR remains amongst the most volatile emerging market currencies due to SA’s weak macroeconomic and fiscal backdrop. As such, although we are seeing the ZAR display a healthy degree of resilience at the moment due to the improvement in SA’s terms of trade, should global conditions deteriorate, dollar liquidity dries up, or international commodity prices plunge, the ZAR would likely come under significant selling pressure. Therefore, we maintain the view that investors should use periods of ZAR strength to position themselves offshore, given expectations for the ZAR’s resilience to diminish in the medium to longer term.