Rand under pressure after US downgrade

Rating agency Fitch recently downgraded the US government’s credit rating. Rather than impacting the US dollar, this move has pushed the rand above R18/USD for the first time since mid-July.

Following a tumultuous start of the year, when many feared the rand would surpass R20/USD for the first time, the rand stabilised in July, dropping below R18/USD for a large part of the month.

However, the rand has been on an upward trajectory since the end of July, trading above R18/USD since the start of August.

On Wednesday, 2 August, Fitch, one of three major independent agencies that assess creditworthiness, cut the US government’s credit rating from the top level of AAA to a notch lower at AA+.

This followed concerns over the state of the country’s finances and its debt burden.

However, the dollar strengthened in reaction to the news, while the rand weakened almost 1.4% against the dollar and was trading at its lowest level in almost three weeks on Wednesday.

Stanlib chief economist Kevin Lings told 702’s The Money Show that this downgrade is not a “game changer” and the US does not face any serious financial risks.

Rather, this news highlights that markets are currently “incredibly sensitive and nervous”.

“People are worried about a global slowdown, a global recession, certainly worried about the US going into recession, and about interest rates and what they’ve done and what damage they may inflict,” he said.

“In this world of increased uncertainty, when you downgrade the world’s biggest economy and arguably the safest asset in the world, that feeds into a whole range of risk-off and uncertainty, and South Africa becomes a victim.”

Lings explained that the US dollar is – rightly or wrongly – considered the safest currency in the world. Therefore, even if the US is downgraded, markets go to the dollar and US government bonds in times of uncertainty.

The US, therefore, benefits from this downgrade while assets like the rand that are considered more “risky” come under pressure.

Lings does not believe this downgrade will spark policy changes in the US government. Rather, it merely serves as a warning about the country’s debt burden and will likely be absorbed by the market.

“The US has an extraordinary amount of debt. Their government debt sits at almost 113% of GDP. That’s exceptionally high, and it’s been increasing for several years, and it doesn’t look like it’s about to recede,” he said.

The US budget deficit also sits at over 6% of GDP, indicating a notable failure of fiscal management. “If that was South Africa, we’d be accused of lacking fiscal discipline.”

In addition, there is a lot of uncertainty surrounding the US debt ceiling, which constantly needs to be increased “to the brink where you’re not sure if they’re going to raise the debt ceiling”.

However, Lings said there is no risk that the US would default on its debt.

“What is happening here is that Fitch is saying, when we compare the US with other AAA-rated countries, the US doesn’t stack up,” he said.

Compared to these other countries, the US does not manage its debt to the same extent and does not exhibit the same quality of management.

Fitch is also warning that the US government will find itself under increasing pressure due to its ageing population. 

An ageing population implies an increase in social and medical payments, making it highly likely that the government debt will escalate even further.

Head of multi-sector fixed income at Schroders, Lisa Hornby, agreed that the repercussions of the downgrade on the US will likely be limited.

“That being said, we do think that over the medium term, it will cause investors to take a second look at the US debt burden and the sustainability at these levels,” she said.

“It is very unusual to be running a budget deficit of 8.5% in a non-recessionary period, and we suspect that over time, this will increase the term premium demanded for US Treasuries and put downward pressure on the US dollar.”