FxWirePro: A Glimpse At ZAR’s RV And Delta-Hedge Trades On Looming South African Debt Crisis

Due to global recession fears and rising risk aversion yesterday brought a further sell-out for many EM currencies. The rand was amongst the biggest losers over the past days and reached new lows against USD and EUR. This is due to investor concerns that the country could slide into a debt crisis in view of the looming global recession and the immense domestic challenges. This is also reflected in the continued rise of credit default swaps (CDS) which had already risen ahead of Moody’s rating downgrade. Clearly confidence amongst investors is dwindling that President Cyril Ramaphosa’s government will be able to cope with a crisis of this magnitude. In view of the overstretched public finances the Minister of Finance signalled that he would request financial support from the World Bank or the International Monetary Fund if his country was to run out of funds to fight covid-19, but that negotiations had not started yet. The country resembles a car screeching through a narrow bend on two wheels with the precipice on the far side. It will take a lot of skill to manoeuvre out of that. Hardly surprising therefore that ZAR investors are getting cold feet. An end of the ZAR losses does not seem in sight against this background.

There are some technical positives for ZAR, which under normal circumstances may be sufficient to stabilize the currency, but amid end-of cycle concerns are probably not a good guide. 

For completeness, we review valuation and positioning below. The medium term outlook for ZAR remains very negative based on weak growth, prospects of much lower carry and a negative BoP dynamics. Yet, our risk appetite index has reached extreme low levels and ZAR is starting to screen cheap in our BEER FV model.

As such we took profits on our bearish trades. Lacking directionality though momentum to keep USDZAR above 18.00 levels.

Consider a RUB – ZAR RV trade, supported by the earlier screener on skews: Sell 3M delta-hedged USDRUB 25D call @10.9/11.3 and hedge it with 3M delta-hedged USDZAR 25D call @16.325/16.725, equal vega. Courtesy: JPM & Commerzbank