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The broad risk asset rally seen in the new year continued last week as the US Federal Reserve, in an unexpectedly dovish statement, said interest rates would remain “exceptionally low” until at least late 2014. The Fed, which had earlier indicated these low rates would be maintained until mid-2013, also did not rule out further asset purchases to help the US economy. This news combined with recent mostly better US economic data and reduced signs of the euro zone stress — the sovereign bond yields of Italy and Spain retreated from unsustainable levels — to propel global growth-focused assets to multi-month highs.

$ fell against all major currencies after the Fed’s pledge, spurring market participants to seek higher-yielding assets. $ declined for a second successive week against €, the longest streak in three months, on speculation the US central bank will enact further monetary stimulus and that Greece would reach a deal with private-sector creditors to restructure its sovereign debt. $ fell 2.2% against €, after dropping 2% last week, its longest losing streak since October.
$ lost 0.4% against the Japanese ¥, the first weekly drop this year. € rose 1.8% against ¥. ¥ was one of the biggest gainers against $ last Friday. $ was down 1%, wiping out all its gains in a week that saw an unusual spike in the value of $ against ¥. Sharp falls in ¥ last Tuesday had sparked speculation by traders that Japanese investors were selling the

currency to buy higher-yielding US debt. But the Fed’s dovish stance helped reverse the falls.

In Asia, rupee touched the strongest level in 11 weeks. Gains were limited by concerns Europe will struggle to forge a debt-swap deal involving Greece’s repayment obligations. Rupee continued to appreciate against $ with

Rupee-$ rate falling below 50.00 for the first time since November 2011. General weakness in $ in the overseas market, FIIs continuing purchases of Indian stocks and bonds, and the RBI sale of $s, helped rupee to appreciate. The RBI’s decision to shift its focus to supporting growth and the cash reserve ratio cut, also buoyed the market sentiment. Last week, the rupee-$ pair traded in the range of 49.29-50.486, and rupee appreciated 2% against $.

Going forward, to make the most effective dollar collapse or rally, a clear and strong bearing on market-wide sentiment is needed. In the new year so far, markets seem to have absorbed all signs of trouble (euro zone downgrades, poor 4Q US corporate earnings and weakened global GDP figures) with no change in propensity toward riskiest assets. A move towards greater stimulus by the US Fed would provide temporary fuel to risk appetite, as the effect of such programmes on market sentiment has grown shorter and shorter with each effort. There seems to be a growing expectation for the Fed to introduce another round of quantitative easing sometime in the early second quarter.

Another clear driver for $ is the health of €. Events in the euro zone can offer immediate buoyancy or exact weight to $. That, however, is just as unstable a driver as risk trends themselves as €’s recent rally has contradicted a growing wealth of bearish evidence. Recent economic data and events in the euro zone are falling short of triggering a change in market sentiment.

Market participants would wait for the speculative drift to run out of steam and risk aversion to kick in again. Key US economic data over the coming week (like Friday’s non-farm payrolls) are unlikely to make a definitive turning point in the risk rally. Overall, $ bear trend may not last for long.

Rupee could continue to trade with an appreciation bias against $ as the latter is undergoing a phase of correction after sharp gains in recent months. India’s stock market, which saw sharp losses in 2011, is also recovering some of its losses on reasonably good corporate performance in theDecember quarter. Overall, market momentum remains supportive for rupee. This week, the rupee-$ pair could trade in the range of 48.50-49.50.

— The writer is a senior economist at theRoyal Bank of Scotland N.V.Views expressed here are personal. E-mail: gaurav.kapur@rbs.com