Volatility in equities, greenback could weigh the rupee down

The recent rally in global markets ran out of steam last week. Market participants started to anticipate moves by policymakers and governments to withdraw the extraordinary economic stimulus provided to tackle the financial crisis.

Equity markets fell and commodities retreated. The first concrete indication of a shift came on Thursday with a joint announcement by the key global central banks — US Federal Reserve, European Central Bank, Swiss National Bank and Bank of England (BoE) that some of the emergency operations to provide dollar liquidity would be scaled back from October.

In the currency market, the pound dropped to a five-month low against the euro and lost ground against the US dollar, as comments from Mervyn King, governor of the BoE, came as a green signal to sell the sterling.

King said the pound’s decline was “helpful” in rebalancing the UK economy to be more focused on exports, in reports published on Thursday. Market participants took the comments to mean that the BoE was comfortable with sterling weakness.

The central bank earlier in the week had undermined the pound, by warning that its long-run value may have been fundamentally undermined by the financial crisis. In its quarterly bulletin, the BoE warned that foreign investors might have reassessed their willingness or ability to purchase pound denominated assets and thereby finance the UK trade deficit, pushing the long-run sustainable real sterling exchange rate lower. Over the week, the pound fell 1.88% against the euro, its weakest level since the start of April, dropped 2% against the greenback and lost 3.73% against the yen.

The yen also advanced against other currencies, rising through the ¥90 level against the US dollar for the first time since early February on the back heavy repatriation flows from Japanese exporters ahead of the end of the first half of the financial year. The yen rose to a seven-month high against the greenback on Friday before easing, still up 1.8% on the week. The yen also climbed 2% against the euro on the week.

Meanwhile, the US dollar hit a fresh one-year low against the euro on Wednesday as increasing optimism over the prospects for global growth prompted investors to abandon the relative safety of the greenback in search of higher returns elsewhere.

Its credentials as a funding currency for carry trades was underlined as the Fed at its policy meeting on Wednesday maintained its commitment to keep US interest rates at exceptionally low levels for an extended period. However, the US dollar bounced back against the euro later, marginally stronger on the week. It ended flat against the Swiss franc and advanced strongly against its Canadian counterpart, climbing 2.2% over the week. 

In the local market, rupee appreciated a tad against the US dollar. The Indian unit was undermined by some correction in the stock market. But a steady flow of dollars from portfolio investors and overall US dollar weakness helped the rupee finish the week stronger. FIIs were net buyers of local stocks and bonds worth $1.47 billion during the week. The rupee-dollar pair traded in the range of 47.845-48.27 during the week.

This week, there will be a number of data indicators that may help to signal whether the US recession really ended in the second quarter of 2009. On Tuesday, the September reading of the Conference Board’s measure of US consumer confidence is expected to rise up to a one-year high of 57 from 54.1 in August, but overall, there are some upside risks for this report. 

On Wednesday, the third estimate of US Q2 GDP is due for release, but the results will be market-moving only if we see surprising revisions. The final reading is forecasted to be revised down to -1.2% from -1%. This would still represent a sharp improvement from Q1, when GDP plunged 6.4%.

Readings in line with expectations may not have an impact on the price action, but better-than-anticipated results could fuel carry trades, especially in light of speculation that the US recession may have ended in the second quarter.

On Thursday, the ISM manufacturing index is projected to rise for the ninth straight month in September to 54 from 52.9, which would be the highest reading since April 2006.
With 50 being the point of neutrality, this would also be the second month that the index signals an expansion in activity, adding to evidence that the sector is experiencing a recovery in business activity. The report will be particularly useful because of its employment component as a leading indicator for the all important jobs report to be released on Friday - US non-farm payrolls.

The US non-farm payrolls (NFPs) report is forecasted to show job losses for the 21st straight month in September, though the rate of decline is anticipated to slow further. The consensus estimate is for job losses to decline by 187,000, which would be the smallest drop since August 2008.

The NFP data will be the event to watch, as it is extremely volatile and is one of the key reports that impact the greenback from a pure fundamental point of view. A better-than-anticipated result is likely to provide a boost to the US dollar. However, weaker than anticipated data could weigh on risky assets and push the greenback higher amidst flight-to-quality.

This week, the rupee could continue to be affected by the volatility in the US dollar and the equity market. Signs that the stock market rally could be taking a breather, could weigh on the rupee. Overall the rupee-dollar pair could trade in the range of 47.75- 48.25 this week.

The author is senior economist, ABN Amro Bank. Views expressed herein are personal.