When the global financial environment is uncertain, a useful way to think about the rand is within the context of a distribution of possible outcomes. It is also useful to look at more than one indicator or model, says Nedbank senior strategy analyst Walter de Wet.
De Wet says that there is a non-linear relationship between the rand/dollar exchange rate and oil prices. This relationship tends to be negative over the short to medium term – i.e., a lower oil price coincides with a weaker rand (or higher rand/dollar), he said.
“This relationship may be somewhat counter-intuitive given that South Africa is an oil importer.
“In fact, oil and oil products are South Africa’s single largest merchandise import and, as a result, a lower oil price should imply a stronger rand via an improved trade balance.
“While this view may hold when one takes a very long, structural view on the South African economy, this relationship does not hold on a multi-month and sometimes even a multi-year view, largely due to capital flows.”
De Wet added that the movement of oil captures many global dynamics that the rand is also subject to – hence the negative relationship with the rand/dollar.
These dynamics include:
- A lower oil price coincides with lower global economic growth;
- Weak global growth also tends to coincide with a stronger dollar as demand for dollar (and a weaker rand), as the reserve currency of the world, rises;
- Lower oil and lower growth imply lower commodity prices in general.
“All three of the above points would be consistent with capital outflow from emerging markets (or at least slower capital inflow), including the rand.
“Remember that the rand is a commodity and an emerging-market currency and, as a result, the forces that push oil lower tend to be quite rand-bearish.
“This would also be the reason why the relationship is non-linear – the further the oil price declines, the greater the negative forces on the rand.”
$30 a barrel implies a rand at R17.80
De Wet noted that Brent crude oil currently trades around the $30/barrel level.
With oil at $30, the relationship in the above chart suggests the rand should trade closer to R17.80 against the dollar rather than at the current R18.50, he said.
“Furthermore, if Brent crude oil goes to $40 a barrel, the relationship suggests the rand should move closer to R16.45.”
“Worth noting is that our base-case assumption for Brent crude oil within our broader macroeconomic model is for Brent crude to trade around the $45/barrel level by year-end.
“This view is based on a marginal recovery in global oil demand as countries open after periods of lockdown. This view is also based on supply cuts from both OPEC and non-OPEC members due to the current low oil price. Should oil reach $45, the relationship suggests a rand of R15.50 to the dollar, not far from our six-month target of R15.00 against the dollar.”
Lastly, De Wet not that it is of course possible that the oil price collapses again and stays, for example, close to $20/ on a multi-month view.
“While this is possible, we think it is improbable,” he said.
“History suggests that the bias in the current low levels in the oil price is for some recovery in oil. As the saying goes, ‘the best cure for high oil prices is high oil prices’. The same would hold for low oil prices.”
Although volatility will likely remain high, De Wet said that Nedbank continues to hold the view that the rand has reached a ‘broad top’ and maintain a target of R15.00 against the dollar. “We think of this as a six- to nine-month view,” he said.
At 14h15 on Friday (15 May), the rand was trading at the following levels against the major currencies:
- Dollar/Rand: R18.60 (+0.85%)
- Pound/Rand: R22.61 (+0.21%)
- Euro/Rand: R20.06 (+0.65%)