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Pound to Rand Rate Risking Deeper Setback from Near the Year's Highs

 

"We like ZAR's fundamentals. Its offers a real rate of return, credible central bank policy and is on the right side of higher medium-term commodity prices," - Natwest Markets.

 

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The Pound to Rand rate has more than reversed its September losses in a recovery that has most recently stalled near 2022 highs but it will run the risk of a corrective setback later this week if the Dollar remains on the back foot or if Sterling is disadvantaged by Thursday's Bank of England (BoE) decision.

South Africa's Rand was close to the worst performing currency in the G20 grouping for October while the Pound was among strongest with the net effect being an almost 12% rally from a late September low that has seen GBP/ZAR erase much of the year's earlier losses in the process.

The Rand's underperformance came in another strong month for the Dollar and a period of unusually marked weakness for China's Renminbi but may also have been encouraged by local data casting the manufacturing sector as almost the sole bright spot in an otherwise cooling South African economy.

However, the recovery of Sterling and rally by the Dollar have been more prominent drivers of GBP/ZAR and each of these has stalled in recent trade.

"We flag that our traders continue to be long USDZAR, ultimately targeting the 2020 highs at 19.20, with interim resistance in the 18.50 area," writes Rui Ding, EMEA content lead at CitiFX Wire, in a Tuesday market commentary that would also have bullish implications for GBP/ZAR.


Above: GBP/ZAR shown at daily intervals alongside U.S. Dollar Index and USD/ZAR. Click image for closer inspection. 

 

GBP/ZAR tends to have a positive correlation with USD/ZAR so would potentially benefit if CitiFX is right to expect the latter to reach new highs for the year in the weeks ahead but much about the outlook for the Dollar is hinged on the market's reading of this Wednesday's Federal Reserve (Fed) decision. 

"With no updated forecasts or dots, the message likely to be more nuanced, and the market wanting to latch onto anything that might be interpreted as dovish (even if the Fed is not ending hikes at this juncture)," says Adam Cole, chief FX strategist at RBC Capital Markets. 

"That kind of scenario may provide space for relief in USD/ZAR, with positioning long USD/ZAR," he adds after advocating that clients consider selling USD/ZAR.

While Dollar exchange rates have risen broadly this year, late October speculation about a possibly 'dovish' turn in Fed policy was followed by widespread selling and any continuation of this over the coming days would likely leave the Sterling-Rand pair hanging at high altitude.

This would be especially likely if the Fed confirms that an end of its interest rate cycle is actually near, although the risk is of the bank keeping its options open and potentially even warning that it could seek to lift U.S. borrowing costs above the 4.75% indicative peak marked out in September's forecasts.


Above: Pound to Rand rate shown at weekly intervals with Fibonacci retracements of 200 and 2020 declines indicating possible areas of technical resistance for Sterling. Click image for closer inspection. 

 

"We like ZAR's fundamentals. Its offers a real rate of return, credible central bank policy and is on the right side of higher medium-term commodity prices. This week's budget added to its positive credentials," writes Eimear Daly, a CEEMEA FX strategist at Natwest Markets.

"However, the currency remains vulnerable to the top-down macro environment and we wait confirmation of a Fed pivot before we will look to enter short EURZAR," she adds in a Friday research briefing.

The rub and potential risk for Sterling, however, is that Thursday's Bank of England (BoE) decision leads to a deeper corrective setback for GBP/ZAR.

The BoE warned in September that they would respond forcefully if it appeared that budget plans of former Prime Minister Liz Truss would provide significant support to the economy but since then fiscal policy has been turned on its head in a way that could limit the bank and pose risk to GBP/ZAR this week.

"We think the MPC will have more reasons to be constrained with its hawkishness regarding further adjustments to its monetary policy stance. We look for a 75bps hike in Bank Rate on Nov. 3, but we also think the risks are skewed to 50bps (or simply a dovish hike)," says Stephen Gallo, European head of FX strategy at BMO Capital Markets.

"Regardless of the Nov. 3 outcome, we don't think a shift by the BoE to a less hawkish posture should be viewed as a near-term trigger to sell the GBP aggressively. Using similar logic, we don't think a more restrictive-than-expected policy stance is a reason to buy the GBP either. We would be less inclined to buy dips in the GBP if the MPC is forced into raising Bank Rate even more aggressively," Gallo wrote in a Tuesday research briefing.