Dog Days for the South African Rand

The charts foretell of more weakness for the Rand; its attractiveness to investors has been brought into question by an increasingly risky political and economic backdrop, and it is falling due to an inverted relationship to the strengthening Dollar.

The Pound-to-Rand exchange rate's chart shows Sterling remains in an uptrend despite having pulled back last week owing to domestic political uncertainty.

The fact the correction versus the Rand was comparatively shallow when compared to other currencies – such as the Canadian Dollar for example - is proof the Rand itself is a currency struggling for form and is therefore at risk of any rebound in the Pound.

Indeed, against the Dollar, the Rand weakened instead of strengthened last week, with USD/ZAR rising at the same time as GBP/ZAR was falling (see charts below).

The chart of GBP/ZAR does not augur well for the South African currency in the future either.

The best technique we have for forecasting where it will go next is to exploit the triangle pattern the pair formed after the establishment of the March lows.

The exchange rate broke out of the pattern and had been rising up until last week’s bout of weakness – and we expect it to go higher eventually as the triangle gives a clue as to how high the market will go after its formation.

A target for the breakout can be calculated by taking the height of the triangle at its widest (A) and extrapolating that from the breakout point (B).

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For a conservative or minimum estimate, a ratio of 0.618 of the height of the triangle is used.

0.618 is the inverse of the golden ratio which is a mysterious number which governs many shapes and patterns in nature as well as financial markets supposedly.

Using the golden ratio the minimum target for the breakout on GBP/ZAR is 19.2000.

An initial target for a short trade higher would be the round number at 18.5000.

Confirmation of further upside would come from a re-break above the 18.3278 highs.

Interestingly the charts appear to back up the views of fundamental analysts.

The Rand suffers from a lack of attractiveness to investors when compared to other high yielding currencies, says J P Morgan's, FX analyst, Anezka Christovova

She highlights the ZAR’s “insufficient carry compensation for idiosyncratic risks.”

The Carry trade is type of investment in which traders borrow in a currency with a low interest rate such as the Yen or the Euro and invest the money in a higher interest currency such as the Rand.

In theory traders stand to pocket the difference of the high interest earned and the low borrowing costs; if the Rand rises then that is a bonus.

Yet although ZAR has a high interest rate its carry potential is spoilt by its risks.

“We find ZAR’s yield too low to compensate for political uncertainty, fiscal/ratings risks, and structural growth challenges,” says Christovova.

The Rand is also notoriously volatile versus the Dollar, due to its sensitivity to US interest rates, which is the highest in the emerging market FX multiverse.

This makes J P Morgan utilise the currency as a hedge against a collapse in US stocks.

From a monetary policy perspective, the South African Reserve Bank (SARB) will probably delay the expected November rate cut into 2018, according to both Rand Merchant Bank’s (RMB's), analyst John Cairns and J P Morgan’s Christovova.

“The main reason for taking the November cut off the table, therefore, has to do with risks — not that the MPC should be a deer in risk headlights — which seem to be escalating by the day and can no longer be treated as an exception,” says Cairns, adding:

“An unusual number of eventualities are at play over the next two months, and if the MPC does not lower rates in November, they could do it in January or March, against a more certain backdrop.”

Whilst Christovova thinks there will be a delay due the recent steep sell-off in the Rand, which it is, of course true will raise imported inflation, and the SARB is unlikely to wish to exaggerate with a rate cut.