Rising risk appetite holds promise for Rupee

Hopes of a turnaround in the global economy were bolstered last week as data from the US economy continued to show an improvement and even data from China showed some promise of a recovery. Rising consumer confidence in the US and expansionary factory activity in October raised hopes that the US recovery is gaining pace. Along with this, the recent evidence showing an upturn in China manufacturing bolstered investor sentiment globally.

The US jobs report for October added to the positive sentiment about the labour market, which in turn is crucial for the health of the consumers and the economy. A net 1.71 lakh jobs were added, higher than the market consensus. The report also showed an extra 84,000 jobs were created in August and September than originally estimated.

In response, the US dollar hit its highest level in nearly two months, ahead of the US presidential election tomorrow. The euro, pound, Japanese yen and the Swiss franc fell against the greenback after monthly non-farm payrolls data led to a broad-based dollar rally as market participants reduced expectations of how much longer the US Federal Reserve would continue to ease monetary policy. The yen hit its weakest level in more than six months, following further easing by the Bank of Japan early last week.

The euro traded at its lowest level in a month against the US dollar after the purchasing managers’ survey showed the region’s manufacturing contracted in October.

The rupee weakened over last week due to dollar strength and the RBI’s stance of keeping a tight hold on monetary policy and a dim view of growth prospects. This dampened the sentiment towards the Indian equities as well. The rupee-dollar pair traded in the range of 53.61-54.20 and the rupee weakened by 0.4%.

This week, focus will be on the US presidential election. Any Republican/Romney victory would be viewed as positive for the US dollar, given his dislike of monetary easing. Market participants would also keenly await the results ahead of the US ‘fiscal cliff’ in January 2013 (when tax cuts and increased spending put in place after the sub-prime crisis will have to be reversed automatically over a period of time, to cut the budget deficit).

Data releases from the US and other major economies would be watched to see if they support the emerging picture of global economy turning the corner. If they do, risk appetite can get some more boost. Events relating to Greece and Spain would also be followed closely. Any Spanish request for aid would see the European Central Bank step in to buy government bonds.

Global events will drive the Indian market. Any improvement in risk appetite would be positive for the rupee and the stocks. Global investors would be keenly watching the policy front, however, as the momentum from the government’s recent reforms is weakening.

The rupee would gain more if, along with an improved risk appetite among global investors, the government indicates more reforms aimed at curbing fiscal deficit and boosting investments and growth.

Despite stronger risk appetite, if the US dollar strengthens, then the rupee could continue to slide. Overall, a moderate bias for weakness is likely to persist for the rupee. The rupee-dollar pair will trade in the range of 53.50-54.25.

The columnist is senior economist at the Royal Bank of Scotland NV.  Views expressed here are his own.