Gordhan’s knot: Economic and market scenarios

(Image from The Daily Maverick)

We set out how we think the markets and the economy would perform under three possible outcomes in the Hawks-Gordhan saga.

Gordhan goes

Under this scenario, we expect that USD/ZAR would spike to retest its all-time high of 18.00 in extreme volatility, while bond yields (the R186) would push into the 10.00% – 10.50% range.

The economy would contract in both 2016 (-0.5%) and 2017 (-1.0%) and only trough in 2018. The SARB would be forced to respond to the inflationary consequences of the rand weakness with moderate tightening, but cuts could materialise in late-2017. SA would lose investment grade (IG) status on its foreign currency (FC) rating in 2016 and local currency (LC) rating in 2017.

Corporate and state-owned enterprise (SOE) credit ratings would follow, although more direct explicit National Treasury support could offset some of the pressure on the SOEs.

Continues as it has

In this scenario, the Gordhan-Hawks saga is not resolved, but slowly fades into the background. USD/ZAR would trade in the 14.00 – 15.00 range over the next few months and finish the year at the upper end of the range, due mostly to the Fed, but also because of a persistent high local risk premium. Bonds would trade 8.50% – 9.00% as risks subside while the economy muddles along with zero growth this year and only marginal growth next.

The SARB would remain cautious, but would cut rates next year as inflation falls.

S&P would downgrade SA in December to sub-investment grade, while the other agencies persist with a negative rating bias. Credit spreads would keep widening despite low issuance volumes.

Gordhan is cleared and stays

USD/ZAR would trade down to 13.20, more than reversing the losses seen since the Hawks news broke, and volatility would fall away sharply. Bonds yields would decline to 8.20% in the short-term and further to the 7.75% – 8.00% range in the medium-term.

The economy would still enter into a recession, but the trough in the cycle would be milder than under the “continues as it has” scenario and growth would accelerate to 2% next year. Inflation would fall below 5% next year, allowing rates to be cut earlier than in the base case. As political risk disappears, rating dynamics will stabilise, but there are enough negative developments in the base to result in a one-notch downgrade from S&P in December. On average, the sovereign rating will remain IG.