Pound vs. South African Rand Outlook: Vulnerable to More Downside Although Tough Support an Obstacle
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- GBP/ZAR attempting to pierce below trendline
- Break lower could lead to bearish extension
- Rand to be driven by Fed meeting, budget statement and Moody’s review
The Pound-to-South African Rand exchange rate is trading at around 18.69 at the start of the week after declining 2.20% in the week before. Studies of the charts show the pair has reversed and is moving lower with strength and vigour - a trend which could continue if it can break through tough support lying just below the market level.
The 4hr chart - used to determine the short-term outlook which includes the coming week - shows the pair falling to a key trendline after previously peaking at the October 16 highs.
The steepness of the downtrend following the peak indicates a good chance the pair is now in a new downtrend, albeit a young one.
The established trend is generally favoured to continue, and the pair could well continue lower if it can successfully break below tough support from multiple levels lying just below the trendline.
A move below 18.55 would provide strong evidence for further downside to a prospective short-term target at 18.45.
The daily chart provides more clarity on where the support below the trendline is situated.
Apart from the trendline itself, the 50-day moving average (MA), located at 18.59, is likely to present an obstacle to bears trying to push the exchange rate lower.
The 200-day MA situated at 18.35 will then present a further tough support floor limiting weakness, and if the pair falls to it there is a possibility it could pause and start moving sideways in the medium-term.
The daily chart is used to give us an indication of the outlook for the medium-term, defined as the next week to a month ahead.
The weekly chart shows how the pair made a dramatic reversal at the October 16 highs just after breaking out of the wedge pattern.
In fact, the break higher appears to have been a false one.
The abrupt reversal and move lower formed a reliable bearish pattern called a 2-bar reversal (circled) - a common sign at market turns.
The pair is tipped to decline to support from both the 50 and 200-week MAs at 18.31 and 18.26 respectively. These are likely to present a robust floor where the exchange rate will probably consolidate for a time.
A break below the 200-week MA, confirmed by a move below 18.20, however, would then provide the green-light for a continuation down to a target at 18.00.
The weekly chart is used to give us an indication of the outlook for the long-term, defined as the next few months.
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The South African Rand: What to Watch this Week
The main drivers of the SA Rand over the remainder of this week are the Federal Reserve (Fed) policy meeting on Wednesday (which impacts the Rand via the U.S. Dollar), the budget statement on the same day, and Moody’s credit rating review on Friday.
The Rand is highly sensitive to the movements of the U.S. Dollar and the FOMC meeting on Wednesday at 19.00 BST, as well as key payrolls and ISM data out on Friday, could cause substantial volatility for the greenback.
The Rand is negatively correlated to the U.S. Dollar which means when the Dollar strengthens the Rand weakens and when the Dollar falls the Rand rises.
At the moment the market is expecting the Fed to cut interest rates by 0.25% to 1.75% and if that happens the Dollar is unlikely to shift since it is already expected.
It is on the question of whether the Fed expects to have to make more cuts in the future that the market is less sure and analysts are divided.
From previously expecting several more cuts the market has changed its mind and now does not expect anymore with a high degree of certainty.
Therefore, the risk to the Dollar is if the Fed hints that more cuts could be on the way, or if the dot plot diagram which represents the expectations of each of the Fed board members shows more cuts are expected. This would lead to weakness for USD but strength, conversely, for ZAR.
Of course, the opposite is also possible and the Fed could become more hawkish - which means in favour of higher interest rates - perhaps as a result of a better outlook for trade.
“The reaction of the Dollar will depend mainly on the signals they send for future rate cuts. On that front, I do not think they will commit to anything - I think they will keep their cards held close to their chest... But, if anything, it might be a slightly more hawkish message than the markets are expecting,” says Marios Hadjikyriacos, an analyst at FX broker XM.com.
The other key event is the SA interim budget statement on Wednesday and related announcements on Thursday.
The budget is expected to present the national accounts in a state of decline and a less optimistic outlook for future growth.
If it is worse-than-expected the Rand could weaken as it will increase the probability that Moody’s finally downgrades SA debt to junk status, an event which would catastrophic for the Rand.
Current expectations (based on two sources) are for a treasury revenue shortfall of circa 59bn-45bn Rand, due mainly to Eskom bailouts and VAT refunds, although the latter is set to end soon.
This shortfall is expected to lead to a wider fiscal deficit of between -6.2% and -6.5% of GDP in 2019-20, against a previous estimate of -4.7%.
The GDP growth forecasts in the last (February) budget statement were for 1.5% growth in 2019, 1.7% in 2020 and 2.1% in 2021.
But these are expected to be severely revised down in Wednesday’s budget because of the Eskom related outages in Q1, which resulted in a -3.1% decline in GDP in that quarter.
If the data is worse than the estimates the Rand is likely to weaken.
The final main release for the Rand is Moody’s credit rating review on Friday.
This is the biggest risk factor for the Rand as a downgrade would lead to an immediate outflow of funds from foreign investors pulling their money out of SA government bonds, and foreign investors have relatively large holdings in SA bonds so the damage would be all the more intense.
“A downgrade in South Africa’s credit profile to junk status would see South African bonds drop out of the Citi World Government Bond Index, leading to a dramatic cut in foreign investor holdings from current levels of around $70bn, prompting a rout in the rand too,” says Ranko Berich, head of market analysis at Monex Europe.
Yet it is unlikely that Moody's will downgrade SA a full notch without downgrading its outlook to negative first.
“It has been a long-standing view of ours that Moody’s won’t downgrade South Africa’s credit profile from BAA3 to label it with a junk status this year,” says Berich.
This is backed up by data showing foreign investors have actually been increasing their holdings of SA assets recently, suggesting they do not see a downgrade as likely.
The main risk of a rating cut lies in the growth slowdown caused by Eskom’s Q1 outages and whether they have done enough damage to force a downgrade.
“Investors got cold chills and memories of Q1s economic performance rocked markets. Thankfully, the load shedding was temporary, pushing CDS pricing back down from recent highs and reigniting foreign investor appetite for South African debt, but the cracks in the economy are still apparent. Debt levels are rising and growth remains low, putting pressure on South Africa’s budget deficit,” says Berich.
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