SA Rand and Euro Forecast Lower With US Dollar Tipped to Rally on Exchange Rate Markets Say BofA Merrill Lynch

The driver for the rally in the USD is believed to be a break higher in US bond yields which have been experiencing a period of consolidation. Subsequently, the bond yield advantages in higher-yielding countries such as Australia, Canada, New Zealand and South Africa will decline.

The move higher in US bond yields is being forecast via technical charts, however from a fundamental perspective this call chimes with the observation that the US Federal Reserve will raise interest rates in 2015.

Both the SA rand and euro are believed to be at risk of such a rally.

• For reference, we see the US dollar to South African rand exchange rate (USD/ZAR) trading at 10.5806.
• The euro to dollar exchange rate (EUR/USD) is seen at 1.3467.

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US dollar forecast to rally

BofA Merrill Lynch's MacNeil Curry has studied the charts and told clients US 5yr treasury yields are set to breakout towards the upside, and the US$ should follow suit.

According to Curry:

"For much of 2014, US rates and most FX markets have been characterized by range-bound, choppy trading conditions and a relentless decline in volatility. Technical analysis says that these conditions are about to give way to a more directional environment and higher volatility."

Since last September, 5yr yields have been characterised by an increasingly well-defined contracting range as volatility declined.

"Triangle formations tend to give way to a strong trending environment, most often in the direction of the trend that preceded the Triangle. Conceptually, the pattern can be thought of as a market that is coiling like a spring, building kinetic energy as it matures," says Curry.

Furthermore, "In the case of 5yr yields, we look for a breakout to the topside for 2.02%/2.05% and beyond."

The US dollar is forecast to rally in line with yields

Should the prediction of rising bond yields occur then we can be sure the US dollar will follow suit as money flows into the US to take advantage of rising yield values.

But, what currency pairs will be at risk of a rising USD?

South African Rand, Euro to decline vs USD

The British pound is likely to benefit from interest rate rises at the Bank of England starting in early 2015, this should provide support to the Cable.

However, the European Central Bank is not likely to raise rates for some time, and therefore the euro is a candidate to short against the dollar.

Also in sight is the South African Rand (ZAR) which is subject to a broader decline against the USD from a technical perspective.

Commenting on the prospects of such a scenario, Curry tells us:

"Two currencies which look particularly susceptible to a turn higher in US yields and a stronger US$ are the Euro and the South African Rand. Looking first at EUR/USD, the breakdown from the bearish wedge says that the medium, potentially long-term, trend has turned bearish.

"Initial targets are seen to be 1.3212 (swing target), ahead of 1.3104 (measured move) and then the 1.2777/1.2685 zone. Meanwhile, in the case of USD/ZAR, the pair is in the process of resuming its long-term uptrend.

"The bullish reversal from the 2yr trendline support (now 10.4863) and turn of the 50d moving average from resistance to support (now 10.5951) says the long-term uptrend has resumed and that the pair is set to make new 2014 highs. In both instances, higher Treasury yields should further exacerbate these trends."