Is South Africa The Next Currency Crisis?

South Africa, famous for Great White sharks, could be the next focus for currency vigilantes.

2018 has been marked by various emerging market crises. From Turkey to Argentina, confidence has eroded, resulting in bond and currency chaos. There is a growing focus on South Africa, and our analysis suggests that will continue.

Q2 hedge fund letters, conference, scoops etc

When examining whether an emerging market country is at risk of a currency crisis, the economic indicator of choice is Import Cover. This gives a measurement of the amount of a country’s foreign exchange reserves relative to its imports. It is usually expressed in terms of how many months of imports the foreign exchange reserves are able to buy before they run out. An emerging market country with 10 or more months of import cover is considered to be stable. South Africa’s Import Cover is 5.5 months, down from 7.2 months at the end of 2015. According to World Bank data, that’s about the same as Turkey. (For perspective, China’s Import Cover is 16 months.) What this means is that there is increasing pressure on South Africa’s foreign exchange reserves, which not only have to pay for imports but also have to service the country’s external debt. Reserves are also used to defend a currency from attack via intervention, but a country with low reserves has little defense. And once the currency market sharks get a sniff of blood in the water, it can get quite frenzied very quickly.

Thankfully, we do not have to guess about all the different economic variables that could or could not happen. We rely on what we consider to be the best lead indicator – the market price. The chart below shows the amount of South African rand needed to buy one U.S. dollar. The exchange rate hit a low of 11.5078 in February this year, and it currently hovers around 15. Our Elliott wave analysis is pointing to much higher levels in the exchange rate, meaning a depreciating rand. Expect fears of a South African rand crisis to grow.

About Murray Gunn

Murray Gunn is Head of Research for Elliott Wave International’s Global Market Perspective, a monthly summary of the firm’s 25 analysts’ views on every major freely-traded market in the world. After earning his Master of Arts (Honors) degree in Economics from the University of Dundee in Scotland in 1991, Gunn went into fund management. He quickly realized that textbook descriptions don’t apply to real-world markets, which in turn led him to technical analysis and the Elliott Wave Principle. He worked as a fund manager in global bonds, currencies and stocks, including long posts at Standard Life Investments and a five-year stint in the Middle East at the Abu Dhabi Investment Authority. Gunn then joined HSBC as Head of Technical Analysis. He has served on the board of the Society of Technical Analysts and delivered lectures on the Elliott Wave Principle to students at The London School of Economics, Queen Mary University and Kings College London. You can read Gunn’s commentary in Elliott Wave International’s Global Market Perspective, Interest Rates and Currency Pro Services, and on deflation.com.

About Elliott Wave International

Elliott Wave International is the largest independent technical analysis firm in the world. Its award-winning publications provide useful insights and engaging commentary on all major financial asset classes and indexes around the globe. EWI’s unique perspective on market behaviour and cultural trends sets it apart from other financial publications.

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China Nukes Yuan Shorts: PBOC Raises FX Fwd Reserve Requirement

In the clearest signal yet that the PBOC is drawing a "red line" to further currency devaluation, moments ago the PBOC announced it is raising the reserve requirement for FX forwards to 20%. 

As the PBOC notes, "due to factors such as trade frictions and changes in international exchange markets, there have been some signs of procyclical fluctuations in the foreign exchange market." As a result, the move is "aimed at preventing macro financial risks" with the central bank adding that it will "take counter cyclical measures to keep FX markets basically stable based on market conditions." The new forward foreign FX risk reserve requirement will become effective as of Aug. 6th.

Stated much simpler, what the PBOC is doing is nuking Yuan shorts and forcing a marketwide FX short squeeze.

Commenting on the move, Nomura's x-asset strategist Charlie McElligott said that when this action from the PBoC was previously enacted back in Oct ‘15, the market interpretation was that this shift was "…seen as an effort to restrict dollar purchases when the yuan is weakening."  So here we go again, “REVERSE ENGINES.”

Reuters is also reporting further “interventionary” commentary from the PBoC regarding willingness to take further “counter-cyclical” measures to stabilize FX markets.  

"In the even-larger macro-sense, this is unambiguously a relief trade for risk-assets via the powerful “weakening USD” impact it can have—ESPECIALLY Emerging Markets and Commodities, which have again recently traded VERY sloppy" according to McElligott, who adds that "we see S&P futures rallying powerfully, as “stronger USD” has been a pure “tightening” of financial conditions."

The Nomura strategist accurately concludes that "the PBoC just “eased” U.S. financial conditions."

And sure enough, as the Yuan slides, S&P futures are surging.

Full statement below (google translated):

The People's Bank of China decided to adjust the foreign exchange risk reserve ratio of the forward sales business to 20%.

Since the beginning of this year, the foreign exchange market has been operating steadily. The RMB exchange rate has been based on market supply and demand. There has been a rise in the market, the flexibility has been significantly enhanced, the market expectation has been basically stable, and cross-border capital flows and foreign exchange supply and demand have been generally balanced. Recently, due to factors such as trade frictions and changes in international exchange markets, there have been some signs of procyclical fluctuations in the foreign exchange market. In order to prevent macro financial risks, promote the stable operation of financial institutions, and strengthen macro-prudential management, the People's Bank of China decided to adjust the foreign exchange risk reserve ratio of forward sales from 0 to 20% from August 6, 2018. In the next step, the People's Bank of China will continue to strengthen the monitoring of the foreign exchange market. According to the development of the situation, it will take effective measures to carry out countercyclical adjustments, maintain the smooth operation of the foreign exchange market, and maintain the basic stability of the RMB exchange rate at a reasonable and balanced level.

Today's move is a mirror image of what the PBOC announced on September 8, 2017 when the Yuan tumbled after the PBOC cut its FX reserve requirement from 20% to 0%, sending the Yuan tumbling after the currency had hit its highest level in years. Back then, the offshore Yuan tumbled from 6.45 to below 6.51 in hours...

Obviously the reversal of this move would have just as dramatic a move in the opposite direction, and sure enough, after hitting a one year low of 6.91 against the dollar, the CNH has surged massively, rising as high as 6.825 before finding some support.

And yet, as some traders already noted, there will be a cost to China in terms of the impact of what is effectively policy tightening will have on domestic liquidity.  Specifically, as Citi notes, "the local economy and asset markets will struggle to cope with that and it is not a sustainable policy."

And while Trump may be content that for now, at least, the PBOC has finally drawn a real line in the sand for further devaluation, he will be double happy that China no longer will permit Yuan devaluation as a currency war response to rising tariffs, effectively handing Trump leverage in the trade war, if only for the time being.

Fonte: qui