Economic risks are now well priced-in and markets are too pessimistic on South African politics, according to Morgan Stanley, and the charts are also pointing toward a possible recovery for the Rand.
Looking at recent price action on the charts, we note the longer-term weekly chart is showing the Pound-to-Rand exchange rate rising within a sort of wedge pattern from the March 2017 lows.
The exchange rate has recently overshot the upper border of this rising wedge (circled) in what we had thought, in previous forecasts, was an exhaustion break.
Exhaustion breaks occur when the exchange rate breaks out above the upper channel line in a rising channel, and are indicative of the uptrend reaching a peak, thus explaining the use of the epithet "exhaustion".
A reversal lower is expected to follow.
The fact that the break on GBP/ZAR coincided with a touch of the 200-week MA, reinforces the possibility it may mark the end of the short-term uptrend from the March lows.
The 200-week MA, like all long-term MAs, has support and resistance properties, which means it can provide a tough obstacle against the direction of the trend and it is often the case that prices reverse at long MAs.
Taken together, the break higher and the encounter with the 200-week MA, suggest a strong possibility the trend could be reversing lower.
The daily chart, however, looks less bearish.
After the exchange rate peaked on October 26 it fell back down inside the channel but a strong green up day on November 3, has revived hopes for the uptrend, after forming a two-bar reversal pattern.
However, it would require a clear break above the 18.92 highs to confirm an extension higher, to a target at 19.35.
This target is calculated by assuming any further up moves will complete an ABCD pattern, which we have labeled on the weekly chart.
ABCD patterns are composed of three waves and look like zig-zags.
The A-B wave and C-D are usually of a similar length.
The ABCD pattern on GBP/ZAR began at the late August lows and has been labeled on the weekly chart above.
For C-D to equal A-B GBP/ZAR would have to rise to 19.35.
Morgan Stanley Bets on a Rand Recovery
The Rand could receive a boost over the coming weeks, according to strategists at Morgan Stanley, as South Africa's economic and political risks are now well priced into markets and the currency is almost certain to benefit from an anticipated downward-correction in the US Dollar toward year-end.
“We think the ZAR is a good candidate to position for the rebound in Emerging Market currencies that we expect to occur over the coming weeks,” says James Lord, a foreign exchange strategist at Morgan Stanley.
South Africa’s Rand shed 4.2% against the greenback during the month to November 06, due to domestic developments and an appreciation of the US Dollar - which always hits emerging market currencies.
“Now that the market has had time to adjust to the negative South Africa budget, we think that the risk/reward of a long ZAR position looks more balanced,” Lord writes, in a recent note.
South Africa’s currency has been beset by a hatrick of headwinds in 2017, with a weakening outlook for GDP growth and increasing concerns over the national financial position both weighing heavily throughout the year.
Political risk has also been seen becoming an increasingly dominant driver as year-end approaches, with the ruling ANC party set to elect its next leader at a December conference. Hopes that a reformist leader will rise from the ashes of scandal-ridden party have been high.
“Of these, we believe the first two are now well understood and priced by markets, particularly following the recent medium-term budget statement,” says Lord. “And on the third driver, we have a more constructive view on the outcome of the December ANC Conference than the market expectation.”
The Rand wasn’t alone in its recent weakness as the Turkish Lira and Mexican Peso were also victim to what was a fierce sell-off in emerging market currencies during October, brought about by both domestic developments and Dollar strength.
“With the USD likely to reverse its recent upswing, these three currencies are likely to gain the attention of investors who want to position for a rebound in EM. Of them, we think ZAR represents the best value,” says Lord.
Chart showing Rand Vs the Mexican Peso. Captures Morgan Stanley stop loss level and target.
Lord and the Morgan Stanley team are betting on a rise in the value of the Rand relative to the Mexican Peso. They are targeting a move up to the 1.45 level and have a stop loss set around 1.31.
“The South African rand has been a significant underperformer this year and our 14.3 (USD/ZAR) year-end target was hit last Friday. While there remains a high degree of uncertainty, we think that risk/reward is more balanced at current levels,” the strategist writes.
Chart showing the Dollar Vs Rand. Captures October's Dollar rally.
The Morgan Stanley team is forecasting that a reformist candidate (Cyril Ramaphosa) will win the December ANC leadership vote, creating scope for what would likely be perceived as a positive change in South African politics.
“If our view were to prevail, we think there would be a meaningful rally in the currency, or at the very least outperformance versus the rest of EM should global conditions prevent a recovery versus USD,” says Lord. “For this reason, we have moved our stance on ZAR from bearish to neutral and recommend a long ZAR/MXN.”
News, Data, and Events for the South African Rand
The Rand is extremely vulnerable to moves in the Dollar, to which it is negatively correlated, and so Rand-watchers should follow the machinations of the US tax reform bill currently working its way through Washington.
The Dollar matters because South African businesses hold a lot of USD-denominated debt or debt sourced in the US, so when the Dollar rises the level of their debts do too - which is seen as negative for growth since they have to spend more on servicing their debts.
Final approval of the tax bill is not likely until the end of the month, around thanksgiving, as a minimum. But in reality, even this may be too early given the consensus is that approval will take until the new year due to there being many 'wrinkles' and points of contention within the draft bill. Meanwhile, the South African economic data calendar is quite bare.
"Rand risks are diminished by the empty data and events calendar. The only meaningful data releases are the Chinese monthly rush, out on Wednesday and Thursday mornings, but global markets have been largely ignoring the Chinese figures in recent months. The progress on US tax reform will continue to get a lot of attention but should not move the market given the road is still long and hard," says John Cairns, a foreign exchange analyst at Rand Merchant Bank.
News, Events, and Data for the Pound
Above: Michel Barnier and David Davis. (C) European Commission.
Last week saw the Bank of England (BOE) take the momentous step to raise interest rates for the first time in 10-years.
Yet no sooner had the rate hike been announced that the market moved on to the next topic of discussion, which is whether or not the hike was a one-off or a part of a series.
The main determining factor appears to be Brexit uncertainty - if talks go smoothly the BOE is more likely to raise rates again - if not then they will probably err on the side of caution and leave the one rise until a clearer picture of what post-Brexit Britain will be like emerges.
Remember the rule of thumb is higher interest rates = a stronger Pound.
"We agree that a deal is the most likely outcome, and based on this we believe that market expectations for a cumulative 0.5% of additional interest rate rises by mid-2020 look low. Rather we think the MPC would like to follow a path similar to that of the Federal Reserve, which has raised rates by a cumulative 0.75% since its initial hike in December 2015," says Pimco Analyst Mike Amey.
Brexit negotiations commence once again in the coming week with all eyes turning to Friday's press conference to be hosted by the UK's David Davis and the EU's Michel Barnier for clues on progress.
Markets will want to see signs of progress that will allow the progression of talks from issues surrounding the divorce to that of trade. Of particular concern is the securing of a transitional deal, widely expected to last two years.
Businesses want certainty and the transitional period will be critical to providing the stability required to make investment decisions.
“Given the Government’s ambitious timetable, to agree on a transitional period early next year and the future relationship altogether by next October, it is crucial for the second phase of talks to start in January,” says Andrew Wishart, UK Economist at Capital Economics.
All in all, this is to say that in the week ahead news about Brexit will remain a high priority for currency dealers.
As far as the hard data front goes, it is a relatively quiet week with no tier one releases on the radar.
The first release is the BRC Retail Sales Monitor released just after midnight on Tuesday, November 7.
This will provide an up-to-date snapshot of the most recent retail sales activity.
Next, we have Halifax House Prices out at 08.30 on Tuesday and is followed by the House Price Balance from the Royal Institute of Chartered Surveyors, just after midnight on Wednesday, November 8.
On Friday Industrial and Manufacturing Production data for September is released at 9.30, with the former expected to come out at 0.3% versus 0.2% previously, and later suggesting a 0.3% versus 0.4% previously.
The Trade Balance is released at the same time and is expected to show the deficit narrow to -12.8bn from over -14bn previously.
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