Dollar’s rising strength would continue to weigh on the rupee

Financial markets remained firmly in the grip of risk aversion last week. Equity markets across the globe witnessed sharp losses with a deterioration in market risk sentiment. As a result, in the currency market, the US dollar was by far the best-performing major currency.

A positive surprise in the form of fourth quarter US GDP data helped boost the low-yielding greenback too, and the currency recorded third consecutive week of fairly substantial appreciation against the euro. 

The euro dropped to a six-month low against the dollar as concerns over the health of Greece’s public finances escalated. Worries over the ability of the nation to fund its budget deficit dominated the currency markets, as participants followed the movements of Greek government bond yields compared with their German counterparts in order to ascertain the risk of a sovereign default.

The euro hit its weakest level since July 14, 2009 on Friday after the spread of the yield of 10-year Greek bonds against German Bunds hit its highest level since Greece adopted the euro in 2001.  The pressure on the euro continued as uncertainty persisted over a potential bailout for Greece.

Over the week, the euro fell 1.9% against the dollar, dropped 1.3% to a five-month low against the pound and lost 0.5% to a nine-month trough against the yen.

The greenback rose as US real GDP growth came in much stronger than expected, showing a rise of 5.7% in the fourth quarter, much above consensus forecasts of 4.5%. Over the week, the greenback rose 0.7% against the pound, gained 1.8% against the Swiss franc and climbed 1.8% against the Australian dollar.

The US dollar also advanced against the yen after figures showed consumer prices in Japan fell at a record pace in December, prompting the government to reiterate its call for Japan’s central bank to step up its fight against deflation. Japan’s finance minister, Naoto Kan, urged the Bank of Japan to work with the government through “appropriate and flexible” monetary policy to support the economy, maintaining pressure for possible monetary easing or even government bond purchases. The yen fell 0.5% over the week against the greenback.

In the local market, the rupee too remained under pressure against the dollar last week. The stock market slide continued with BSE Sensex losing 3% of its value over the week. Even FIIs turned net sellers and offloaded local stocks and bonds worth $846 million during the week.

The Indian unit however, managed to finish the week almost flat against the greenback as dollar selling emerged at higher levels for the rupee-dollar pair. The rupee was also helped by the RBI raising its growth forecast for the current fiscal to 7.5% from 6% earlier and aggressively tightening the monetary levers by raising the CRR by 0.75% to drain out Rs36,000 crore of liquidity from the banking system. That along with a 2% increase in the RBI’s March 2010 inflation forecast to 8.5% also raised the expectations of a policy rate hike over the next couple of months. The rupee-dollar pair traded in the range of 46.08-46.425 over the week.

The first week of February promises a great deal of economic event risk and currency options markets have priced in considerable price moves in the major pairs. The critical question is whether the dollar will continue to react positively to better-than-expected data or will the positive surprises on the data lead to better risk appetite and pull the greenback down.

At the start of the week, market participants will get US personal income and spending data as well as the ISM manufacturing survey results on Monday. Consensus forecasts project modest pullbacks in income and spending growth in December, while US manufacturers are likely to report slower gains in activity for January.

Substantive surprises in either release could easily force sharp dollar moves but sharper moves may occur later in the week with the release of the ADP employment report, ISM Services, and US non-farm payrolls (NFP) releases.

Market participants will pay extremely close attention to surprises in NFP results, while earlier ADP and ISM numbers will likely shape consensus estimates for the monthly employment figure change.

Consensus market estimates predict that the US labour market added a net 13,000 jobs through January, but the monthly figures are very volatile, and prone to major revisions. Yet market responds to the headline data and any significant surprises in earlier ADP Employment and ISM Services Employment Index figures could easily set the stage for similar surprises in market-moving non-farm payrolls numbers.

Recent momentum clearly favours dollar appreciation but sharp gains in the greenback make a very-short-term correction possible. Market participants would closely watch the equities market and other risk barometers surrounding major data releases out of the US and other large economies.

In the local market, the rupee could remain under pressure for another week on the back of key data releases in the US.

The rupee-dollar pair would continue to take cues from stock market movements and risk sentiment among global investors.

Market participants would also follow the reforms which are being talked about ahead of the announcement of 2010-11 Budget, to be presented on February 26. For instance, there is a possibility of introduction of free-market pricing of petroleum products, which could help curb the subsidy bill of the government. Any other initiatives by the government to improve the investment climate in the country would be positive for the rupee. Overall the rupee-dollar pair could trade in the range of 46.00-46.50.

The writer is senior economist, ABN Amro Bank, and can be reached at gaurav.kapur@in.abnamro.com.
Views are personal.