FX Update: Playing The EM Relief Rally Through Being Long Rand

A neat combination of last Friday's somewhat weak US non-farm payrolls numbers (which reignited doubts concerning what had previously become almost a foregone conclusion about the September start to the Federal Reserve's tapering of its asset purchases), continued disagreement over Syria, improving Chinese trade numbers published during the weekend and upward revision to Japanese Q2 growth numbers have collectively worked to lift riskier asset classes and emerging market currencies.

In this emerging market relief rally, South Africa catches our attention for the potential it holds to be a near-term relative outperformer. This resource rich African nation has been long perceived to be one of the weaker links in the emerging market chain due to moderate commodity prices, weaker external demand and seemingly unending trouble with labour unions. Furthermore, the weak rand has certainly not alleviated the upside risks concerning the inflation outlook. This combination of upside inflation risks and resultant sluggish growth means the monetary policy framework in South Africa is quite a challenge.

Strike end provides relief to rand
The recent end of the local mining strike action in South Africa has brought much relief to the battered currency. In combination with improving global economic factors and steadying gold prices, the South African rand, which is now technically in a rather interesting place, could be expected to pare its sharp August losses. Below, we provide a detailed technical outlook for USDZAR with an emphasis on the downside dynamics and key support levels, as well concrete target levels for sustained downside selling action.

None of the above mentioned factors, however, negate or mitigate the continued risks for emerging markets in the medium-term future. This week's series of US Congress votes will determine the likely next stage with regards to the Syrian situation, which, if it should re-escalate, would quickly mean renewed trouble for high beta emerging market currencies. Furthermore, with the Federal Reserve's September meeting now approaching, the reshuffled odds of when the announcement will come about its first step to reduce asset purchases makes for volatile and uncertain trading conditions.

With structural challenges in many of the EM countries compounding global risk factors, one ought to approach all rallies in such markets with a good degree of caution. We are likely to be only in the beginning of what will probably be a prolonged period of moderation in high growth markets and riskier EM asset classes.

USDZAR continues to find selling interest below 10.5085
USDZAR shows signs of a daily reversal pattern with the currency pair having little follow through after breaking the highs from June at 10.3600. As of writing this, USDZAR has tested trend-line support from the May lows of 8.8293 and a daily close below this would open up for further downside acceleration. The first target would be 9.8671, which is the 38 percent retracement in the 8.2993-10.5086 wave and after that 50 percent at 9.6689 in the wave. But for the overall technical picture to trade with a full bearish bias, a break of neckline support at 9.6121 is needed.

On the flip side, for the short-term bullish bias to re-enter the technical outlook, a close above 10.4000 is needed.

USDZAR at critical trend-line support