Bottom line:

  • Although the ZAR Sentiment Indicator (ZSI) is trading at levels last seen thirteen years ago, thus far, the ZAR has failed to respond in the manner predicted by the indicator. The reason is that the ZSI is an indicator that offers perspective nine months in advance. Nine months ago, the current phase of load-shedding was not envisaged, and the deterioration in sentiment was also not predicted.
  • Therefore, the ZSI does not reflect this in the predicted path. Furthermore, one questions the validity of the remaining path, given the intense nature of load-shedding. ETM acknowledges that the ZAR may perform differently until the market comes to terms with the full consequences of this load-shedding and what might happen through winter when the demand for electricity usually increases.
  • Nevertheless, as a barometer for hedging activity, it is important to note that this indicator reflects great reluctance by the professional market to hedge against significant further ZAR weakness from these levels. It is a sign that the ZAR is stretched and that there is a lot of bad news priced in.


Baseline view:

In its naked form, the ZSI still implies a strong ZAR recovery back to at least 15.00/dlr. However, given recent developments concerning load-shedding, that view may need to be tempered. Nonetheless, it still indicates that there is good justification for why the ZAR might still stage some recovery from its most recent lows. Exporters might still consider covering forward.

ZSI pointing to improved ZAR outlook

Typically the correlation between the ZSI and the y/y growth in the USD-ZAR lagged approximately nine months averages between 60-65%. It is a reliable guide for direction in most instances, and it is an indicator we, therefore, take seriously. Towards the end of 2022, the indicator rose sharply and recently to its highest levels in some thirteen years on the high-frequency version (grey line). One would therefore expect a strong performance by the ZAR that would need to appreciate back towards 15.00/dlr if it were to keep pace with the ZSI. That may sound like a tall order and likely is, given the circumstances.

What the ZSI struggles with, given that it prices in trends nine months in advance, is adverse developments unforeseen at the time. One such event has been the persistent and intense load-shedding schedule, the greylisting, and the prevailing politics, including the cabinet reshuffle. It has been a difficult start to the year and undermined the dynamics that might otherwise have resulted in ZAR appreciation and a significantly improved inflation outlook. What is left is to establish whether the ZAR will ignore the signals of the ZSI, or whether the correlation between the ZSI and the ZAR will re-establish itself.

Private sector starts to pick up Eskom’s pieces

Assessing the Eskom situation does not make for easy reading. Eskom effectively produces the same amount of electricity it did twenty years ago, and judging by the trend, it is deteriorating. Stage 6 load shedding is the result, and its impact on the economy and its prospects has been staggering.

The losses related to this calamity stretch far beyond just the cost of mitigating load shedding. The real damage is contained in the opportunity cost and the de-industrialisation that has occurred. How much bigger might industry have been? How many more people would’ve been employed? How much bigger might the tax base be? Would our credit rating have remained in investment grade?

We can all guestimate the answers to these questions, but the only differences would be the degrees to which SA would’ve been better off. However, for all the negativity surrounding Eskom, there may be some green shoots to keep track of.

Data analysis on how much Eskom produces relative to total electricity production reveals a slow diversification away from Eskom. Increasingly, the private sector, as reflected in the bottom half of this chart, is gaining momentum. Any further liberalisation of the electricity sector is bound to translate into a steeper uptake by the private sector which would induce higher degrees of fixed investment, a welcome silver lining to an otherwise very dark cloud.

Private sector becomes more efficient

Given the picture above, it is impressive that the SA economy has managed to eke out any growth at all. Data shows a strong positive correlation between the intensity of electricity usage and the degree of development in an economy.

Modern-day economies rely heavily on energy to remain productive, and SA is no exception. One might argue that SA is even more dependent on electricity for growth than most economies due to the size of SA’s energy-intensive mining sector.

So this enormous reduction in electricity intensity can only imply that SA has become more efficient in its electricity use than at any time in the past decade. Sadly, it also implies that some deindustrialization has occurred as infrastructure degrades and industrial sectors find it progressively harder to do business in SA.

Nonetheless, the take-home point in this chart is that SA has become more efficient, which is a positive upshot. It sets the country up nicely to perform well if the electricity crisis is resolved.

USD remains very overvalued

By now, a lot has been priced into the ZAR, with most of the news on Eskom well-understood and covered in detail by the press and the authorities. Load shedding has undoubtedly impacted the ZAR negatively and led to a dislocation in the relationship between the ZSI and the performance of the ZAR.

However, equally important is the performance of the USD and what the prospects for the USD might be. It is helpful to consider the USD’s valuation and gauge just what investor expectations have been priced in.

The accompanying chart shows a very long-term USD chart. Although the USD’s overvaluation does not guarantee that the USD cannot surge again, it does offer some insight into how much support it has received in recent years. It could only do so with some justification, implying a fair amount of news and expectations inherent in the trade-weighted USD price.

USD speculators remain bearish the USD

Speculators, for the time being, remain bearish on the USD. Net long positions switched to net short positions through the end of January into February, and the net result has been to detract from the USD’s performance. The USD may have recovered from its recent lows, but as a trend, it remains bearish.

Furthermore, there is a lot of USD unwinding to unfold still if one believes that the monetary policy cycle was one of the key reasons for the USD’s appreciation in the first place. Although inflation in the US shows signs of remaining stubbornly high, it will reverse at some point.

Just as the US led the rest of the world into hiking, it will likely lead the rest into cutting rates. The implication is that whatever was priced into the USD will be priced back out, which could translate into a USD correction. The risk to this view is that global stock markets are questioning valuations given the anticipated slowdown that will negatively affect stock market performance.

Global equity markets pose a risk to a weaker USD view

especially in the US, are elevated and on the more expensive side of valuations, the risk of a correction always exists. Such a correction in global equity markets poses the most significant risk to any stronger ZAR view.

The danger is that a sell-off in global equities will translate into a rise in volatility, as reflected by the VIX (red line in the chart bottom left). An inverse relationship exists when the VIX rises or falls to extremes. The danger in a stock market sell-off is that the VIX will spike, and EM FX will come under collective pressure. The ZAR is now vulnerable due to the load-shedding incidents, the greylisting and the political backdrop. As it is, the ZAR has underperformed other emerging market currencies this year and could continue in a world of stock market distress. The opposite also holds true, although, with interest rates rising as they are, the risk of a sell-off in stocks far exceeds the probability of another rally.

CEOs are concerned that the outlook for growth and earnings will deteriorate (chart bottom right). They are concerned that the
deterioration will impact their earnings per share and, as a result, will negatively influence the share price. While equity markets,