ZAR strengthens against GBP but a Moody’s Credit Rating Review on Friday and bullish configuration on the GBP/ZAR chart raise questions over how far this strength can extend.
The Pound to Rand exchange rate (GBP/ZAR) has fallen back to near-term support located at 17.50 on Tuesday November 22.
The pullback comes after a particularly strong period for Sterling which has risen strongly following the election of Donald Trump.
Emerging market currencies, on the other hand, have sold off heavily.
GBP/ZAR’s charts show a pair which has rallied strongly from what may, in hindsight, be a major bottom.
Rallies off major lows are normally very strong in the beginning and GBP/ZAR's chart fits that criteria.
The pair has also broken up through an important trendline and consolidated, forming what appears to be a convincing, unfinished, bullish flag pattern.
We see a high probability the upside potential promised by the trendline break and the formation of the bullish flag will be fulfilled and the pair will break higher and move up to the 19s.
A break above 18.30 would confirm such a bullish move and be expected to reach 19.10, fulfilling the target for the flag and the trendline break.
Moody’s Rating Review Ahead
A major risk event for the Rand on the horizon is the spate of end of year rating agency assessments, with the first on Friday from Moodys.
Although the feared downgrade to junk status is unlikely given Moody’s have South African debt two notches above junk and a downgrade would be expected to only move it down a single notch, even such an outcome would generate downside for the Rand.
Rand Merchant Bank’s John Cairns notes recent positive economic reforms to the minimum wage may help improve SA’s credit rating:
“These reforms come just as we enter rating season.
“First up, later this week, is Moody’s, the least important of the two big agencies given that they still have SA on two notches above investment grade status.
“It’s a close call on which way they go. Moody’s turned notably more negative in their review in March but did not follow through on it thanks to persuasive policy makers and promised reform.
“Whether Sunday’s last-minute labour-reform progress is enough to keep them from acting is unclear. In the event of a downgrade, the outlook will very likely be changed from negative to stable,” said Cairns.
The Trump Trade Triggers GBP/ZAR Recovery, but it Could now Reverse
Pound Sterling, by contrast, was actually the biggest winner of the Trump trade. Why? It all has to do with expectations for future interest rate moves in the developed world vs developing workd.
The increased cost of borrowing from the US, reflected in US yields, as well as the rising Dollar will increase repayments for the many South African businesses with US loans.
We have seen yields in the UK and US rise sharply after Trump's victory which signals better returns in these investment destinations. The repatriation flow of capital out of SA and back into the UK and US has pushed the Rand lower.
Whether the rise in US yields will continue, depends on how much stimulus is pumped into the economy and therefore the inflationary outlook.
Trump may be constrained by Republicans in the upper and lower houses, some of whom are against infrastructure spending, so whether the rally in yields is sustained or not depends on what stimulus he can get passed in the Republican controlled houses.
However, even if stimulus is much smaller in reality than markets are expecting, the Dollar could still continue rising, due to other factors, such has his trade protectionist agenda, which will reduce imports.
And a stronger Dollar, will still put pressure on emerging market currencies such as the Rand as it will still increase repayment costs on many Dollar-denominated US loans.
However, Unicredit’s Chief Global Economist Erik Nielsen is skeptical that markets are right in pricing in a reflationary surge in public spending in the US:
“I’ll give this present market sentiment no more than 5%-10% chance that it’s right.
“Rather, a modest fiscal easing (tax cuts to corporates and probably individuals), de-regulation of some parts of energy production and some protectionist noise seem a much more likely outcome – which would mean that risky assets might give half their post-election gain back during the next 3-6 months,” says Nielsen.
Yet despite this he is upbeat about the Dollar:
“The one big move I – with the benefit of hindsight – can see some logic in, is the Dollar appreciation.
“Any of my two first scenarios, and some part of the third and messy one, would probably support a strong Dollar, particularly against vulnerable EM currencies, already down 6%-10%.
“And all underpinned by a Fed now on the move."
The Pound: Autumn Statement forms Main Focus
As far as the pound goes, the main event will be the Chancellor’s Autumn Statement on Wednesday, November 23.
Markets will be focused on the amount of fiscal stimulus the government is willing to spend, which if substantially higher is likely to support the pound as it will take the pressure off the Bank of England to print money and use that as stimulus instead.
Talk of stimulus may have been hyped as an admission of ‘outright loosening’ now seems unlikely, according to Capital Economics’ Paul Hollingsworth.
“All eyes are now on the Chancellor, who delivers his first fiscal set piece with the Autumn Statement on Wednesday.
“He will be constrained somewhat by recent poor borrowing numbers and a disappointing set of economic forecasts.
“Accordingly, we expect fiscal policy to be less tight than the current plans, rather than providing an outright loosening.”
The government’s latest borrowing figures out in Tuesday, November 22 – the day before the budget - could provide a hint as to how generous Chancellor Hammond is willing to be.
The reading at £4.3BN came in much better than the estimate for a figure of £5.6bn borrowing by the government in October, from a previous 10.1bn.
Even though this is a positive surprise, it is unlikely to sway the Chancellor into delivering a major fiscal boost.
The release was Sterling-neutral.
Also ahead are Q3 GDP on Friday, November 25 at 9.30 (GMT).
Preliminary estimates had it at a healthy 0.5% QoQ and unless the second estimate seriously disappoints we are unlikely to see much movement from this release.
Tuesday, November 22 sees the release of survey data from the Consortium of British Industry November.