A rock falls in South Africa and a day later the wave hits us
By Thursday evening, risk-off trading was very much the flavour of the big indices in Europe and the US. After a very volatile two weeks, major bourses were expected to stay on track and end the quarter with solid performances across the board but this was not borne out by actual events.
There is a rather strong tradition that indices tend to perform better towards the end of the quarter than during the quarter. Although the end of the first quarter is not as important as the end of the year, it still usually follows this pattern. April then becomes the month in which traders and investors hold their breath, for that is usually when the sell-offs occur as markets shed the excess built into them by first quarter expectations.
In general, all major indices, except for Asia, have performed remarkably well so far this year with many of them posting 8-month, 10-month and even annual highs. Given the still tumultuous conditions in Europe, this was somewhat against expectations but the bull-market revival was indeed welcome to bring some confidence back to battered markets.
If 2010 is known for so-called risk-off trading, then 2011 was a year of consolidation with major indices neither gaining new highs nor tending back towards the lower end. The performance of the first quarter was therefore a bit of a surprise especially given the fact that nothing much has improved regarding the fundamentals of the world’s biggest economies. Also in Johannesburg, the exuberance of international markets was reflected in the JSE breaching the 34000 mark recently for a short period.
But as this week proceeded, it became clear that risk-off trading was back, indices retreated amidst extremely volatile intra-day sessions, and commodity currencies took a beating. The sentiment has turned negative in a spectacular fashion compared to two weeks ago.
Then on Wednesday, an event happened which really knocked some wind out of local markets, and coupled with the general deterioration of the overseas markets, sent the South African currency on a nose-dive.
And this is where the analysis becomes very interesting for us. As there is an almost inseverable umbilicus between Namibia and South Africa, the weakening of the Rand has an equally harsh impact on us. When, therefore, Standard & Poors ratings agency announced on Wednesday it has downgraded South Africa’s outlook from Stable to Negative, I shivered for I realised what will come next: The Rand will be hammered and in its wake, the Namibia Dollar will also go down the slope. And this is exactly what happened. By midday on Wednesday, the first rumbling in forex trading was heard. The Rand weakened rapidly from a level of around R7.60 to R7.66 touching the R7.68 level briefly before closing the day at R7.64.
This does not sound like much considering that we had to endure much weaker and much stronger currencies in the past, but the short timeframe was a warning of more to come.
This trend was re-inforced on Thursday when the battering of the currency continued losing, at one particular point, 11 cents in a matter of minutes. On Thursday just before noon it breached the R7.70 level, missed a couple of beats and went past R7.77 before ending the day at around R7.75.
For a currency that is traded so widely and in such volumes as the Rand, these are big moves. The forex trading displayed a dangerous level of volatility, exacerbated by the fact that it happened in such a short time.
Note that South Africa’s rating was not downgraded by S&P, only the outlook. This indicates to markets that if no positive changes occur between now and the next official rating, it will probably be downgraded. And that is when the fall-out will begin.
We find ourselves in a very similar position. Although Namibia has not been downgraded, our outlook was also downgraded late last year from positive to stable, same as happened in South Africa. The reason given then was the increase in our government debt. If, during the first half of this year, our outlook will again be lowered a notch, from stable to negative, then it will have ramifications on the interest we pay for our sovereign debt.
And it is perhaps this aspect that has the biggest impact on a country’s economy when a ratings outlook changes a gear. It signals to investors, both domestic and foreign, a certain level of risk associated with the debt, both private and public, that originates from that country. Yields go down and interest rates go up as an adjustment of our risk profile works itself through the system.
It sound as if this has little impact on the man in the street but that is not the case. As rates rise on government debt, eventually domestic rates for the ordinary borrower will also have to rise. And that has a major impact on disposable income and consumer demand.