Greenback turns weak on soft non-manufacturing PMI data

On March 27th, considering the issues faced by the South African industry and possibility of a credit downgrade, we had suggested going long in the USD/ZAR pair at 12.42. To option traders, we had advised an investment in a high or above option to gain from the uptrend.

As anticipated, the USD/ZAR rallied after the S&P downgraded South Africa’s credit to junk status on Monday. The currency pair hit a high of 13.9411 and ensured our recommendations ended with a profit.

Now, considering the reasons below, we anticipate a short-term down trend in the USD/ZAR pair.

Capital economics had forewarned the possibility of a credit downgrade of South Africa, by the S&P. Even then, the downgrade had its negative impact on the Rand as this is the first-time South Africa had lost its investment grade status since 2000.

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Oliver Jones, an analyst at Capital Economics, argued that the downgrade would not make a huge difference to the outlook on dollar denominated bonds. The reason is that the spread of those bonds had already increased sharply, once the market came to know that Finance Minister Pravin Gordhan would be dismissed. Gordhan is widely acknowledged as a fiscally prudent minister.

Thus, by the time S&P announced its decision, the market had already priced in the downgrade. Furthermore, the market is now prepared to hear similar announcements from Moody’s and Fitch rating agencies. So, any news of credit downgrade from those organizations will not impact the Rand. Additionally, the country is not likely to face a lot of balance sheet related problems as the economy is expected to fare a bit better than last year.

In the US, the non-manufacturing PMI (Purchasing Managers Index) reading of 55.2, reported by the Institute of Supply Management, reflected a 2.4% m-o-m dip in the economic activity in March. The market anticipated a reading of 57. Thus, it is clear that the slowdown in the economic growth rate below the market’s expectation would certainly weaken the US dollar against the Rand in the days to come.

The currency pair has made a negative divergence with the momentum indicator. The USD/ZAR pair is also facing stiff resistance at 13.80 levels. Speculators (including traders who have used our recommendation to enter at 12.42 levels) are also expected to use the steep rally to book profits at these levels. Thus, a downtrend can be expected in the short-term. The downtrend may extend until 12.96 where the next major support exists.

A Forex trader can go short at 13.80 levels, with a stop loss order above 14.13, to generate returns from the forecasted downtrend. The position can be covered when the pair trades near 13.10.

For binary traders, an investment in a put option is advisable at this point in time. By purchasing the contract when the currency pair trades near 13.80, a trader can look forward to realize gains of about 78% from the downtrend. The contract should also remain active for a period of one week.

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