Re gains a tad as $ inflows improve

The US dollar outperformed other major currencies last week, even as the US Federal Reserve paused its two-year-old rate-hike cycle after 17 consecutive 0.25% hikes. The Fed left the overnight funds rate unchanged at 5.25% in its August 8 monetary policy meeting, noting that inflation expectations are now contained and past rate hikes are restraining demand. The US central bank, however, left the door open for more rate hikes in future, expressing its willingness to raise rates again if inflation pressures persist.

The movement of the US dollar against the euro and the Pound Sterling followed a choppy pattern. The greenback, which has been fairly weak in the past few weeks, saw small knee-jerk sell-off on the Fed rate decision. It later recovered on the balanced tone of the monetary policy statement. Otherwise, the greenback got support from speculators covering their heavy short-dollar positions, built over last few weeks in the run-up to the Fed meeting. The greenback also found support from issuance of US treasuries worth $44 billion last week.

The overall price action in the US dollar-European currency axis derived little direction from the fundamental developments. Among the key data releases, the US trade deficit in June at $64.8 billion printed a little higher than expected $64.5 billion, but narrowed slightly from $65 billion in May. Another piece of greenback supportive data came on Friday in the form of retail sales numbers for July, which showed consumers had continued spending strongly.

The Euro and Pound sterling failed to breach the highs of their recent trading ranges against the greenback. The Pound’s strength was tempered by the less-hawkish-than-anticipated August inflation report of Bank of England, after a surprise rate hike on August 3. Heightened geopolitical uncertainties following a foiled terror attack at the London’s Heathrow airport also triggered US dollar buying.

The Japanese Yen, which resisted the US dollar advances till Thursday, fell sharply on Friday, as the second quarter Japanese GDP report was considerably weaker than expected. The real GDP growth fell from an annualised rate of 2.8% in Q1 to 0.8% in Q2, below the expected 2%. The Yen weakened sharply against the greenback following the GDP data. It also weakened against the other majors on the prospects of widening interest rate differentials.

The Bank of Japan (BOJ) left its policy rate unchanged at 0.25% in its monthly monetary policy meeting on August 11, as was widely expected. BOJ governor Toshihiko Fukui said the bank was in no hurry to increase interest rates, but remained “completely open to any possibility.” Weak GDP numbers and the Fed pause may provide reason for the BOJ to delay further rate hikes, thus worsening the Yen’s relative yield disadvantage.

Among the other Asian currencies, the Thai Baht gained sharply last week. The move was supported by the Bank of Thailand chief’s comment that Baht is unlikely to return to a 38-39 range against the US dollar, and the suggestion that its gains would have been even sharper if the central bank had not taken action to stem gains. In the local inter-bank market, the rupee finished the week a tad stronger against the greenback. The rupee opened the week a shade weaker, as banks bought dollars, noting a sharp flare up in crude oil prices and greenback’s gains against the Yen.

Over the next three days, the rupee gained steadily, closing at 46.40 per dollar on Thursday after a Monday close of 46.585. This move came as dollar inflows improved. Banks sold dollars, taking into account the expectations of a Fed pause and following weak dollar overseas on Wednesday, as the Fed confirmed those expectations. Exporters and foreign institutional investors (FIIs) also supplied dollars to the market. FIIs were net buyers of Indian equities and bonds to the tune of $314.7 million. The equity market gains of 3% were also favourable for the rupee.

On Friday, however, rupee slipped again as the greenback recovered abroad and on the news of possible terrorist attacks in Delhi and Mumbai. Overall rupee-dollar rate moved in the 46.37-46.63 band. The Indian unit gained over 1% against the Yen, Euro and Pound, whereas its gains against the greenback were restricted to 0.1% only.
This week, price action in the international market will depend upon the US data releases. The key among them are the July consumer and producer price inflation reports, US Treasury’s June capital inflows data and July housing starts. The strength of the inflation numbers could decide whether the greenback heads higher, but overall, the greenback would remain in favour.

The rupee thus would face some downward pressure. And the oil prices continue to hover around $75 per barrel, another negative for the rupee. The rupee is likely to trade in the range of 46.30-46.80, with some downward bias.

The author is senior economist, ABN AMRO Bank. The views expressed herein are personal.

E-mail: gaurav.kapur@in.abnamro.com