RBI, US data and risk to drive rupee

Price action in the financial markets was characterised by rising hopes over the euro zone crisis, generally positive corporate earnings news and mostly supportive economic data last week. Signs of a global economic recovery and falling European borrowing costs boosted demand for riskier assets. Better-than-expected US economic data further fueled demand for higher-yielding riskier assets. Risk appetite was also boosted as the IMF proposed its lending capacity be increased by as much as $500 billion. The Fund wants to increase its resources after identifying a potential need for $1 trillion in coming years.

In the global currency markets, € rose for the first time in seven weeks after speculative bets that the 17-nation currency would weaken, reached a record. The difference in the number of futures and options bet by hedge funds and other large speculators on a decline in € compared with those on a gain, or net shorts, was 160,030, the most ever, according to figures as of January 17 from the Commodity Futures Trading Commission.

Market participants covered some of these large short positions, thereby buying € on the back of improvement in sentiment about the euro zone. Last Friday, € fell from weekly highs reached against $ and ¥ as investors took profits ahead of talks between Greece and private lenders to reach  an agreement on restructuring the nation’s debt. The outcome of the private sector involvement talks in Greece this week would be crucial in determining the path of € in the short term.

Last week, € rose 2% against $, the biggest weekly gain since October 14. € appreciated 2.1% against  ¥, after reaching an 11-year low on Monday.  $ was little changed against ¥ over the week. £ rose against $, with some traders speculating that news that a Chinese sovereign wealth fund was buying a stake in Thames Water could be positive for £ which was 1.7% higher against $.

Emerging market currencies gave up some of their gains amid the general risk aversion on Friday, but were broadly higher over the week against $. Asian currencies recorded a third week of gains, led by rupee and South Korean won.

In India, rupee continued to receive support from a weaker $ and increasing capital inflows. FIIs remained net buyers of Indian stocks and bonds for another week with their net purchases touching $1.2 billion. Deposits from non-resident Indians also shored up dollar inflows as interest rates offered on these deposits have been increased sharply by banks, following the RBI’s deregulation of these rates. Last week, rupee appreciated by 2.3% against $ and the  Re-$ pair traded in the 50.075 - 51.80 range.

In the week ahead, market focus will turn to the US Federal Reserve’s monetary policy committee’s meeting on Wednesday and end-of-week US GDP growth data. The Fed is very unlikely to change interest rates or monetary policy stance, but it will unveil a fairly significant new tool to guide the markets — interest rate forecasts. The Fed will show when the interest rates will be raised through 2016 — giving a much more specific view on when markets can actually predict its next moves. The Fed’s statement and forecasts may have fairly significant effect on $, US equities and other key asset classes.

Markets will otherwise look at US GDP growth figures with great interest. Surprisingly robust domestic unemployment figures have boosted expectations of economic expansion, and market participants predict the economy grew at its fastest pace since the second quarter of 2010. Such predictions, however, leave a lot of room for disappointment; and riskier assets, especially equities, would see a sell-off on any big negative surprises in the data. $ could see sympathetic declines (or advances) if the GDP data affect outlook for broader growth in any significant way.

Market participants would otherwise keep a close eye on global financial market risk appetite. $ has enjoyed significant rallies on any sudden sell-offs in the S&P 500 equities index and similar risk appetite barometers. The S&P has rallied to fresh multi-month peaks so far this year. Such remarkably consistent strength leaves clear risk that markets can reverse sharply.

Local market participants would also be following the last quarterly review of the RBI’s monetary policy for the current fiscal, due to be announced tomorrow. The Indian central bank is widely expected to keep rates unchanged. Therefore, its assessment of growth and inflation dynamics would be crucial for the market to understand when the RBI is likely to cut rates.

Other than that, the price action in the €-$ pair will be crucial too as any short-covering driven strength in € will also be beneficial for `. Global risk appetite may see a squeeze this week and that could see ` consolidating its recent gains against $.

Overall, the  Re-$ pair could trade in the range of 50.00-51.50 with momentum favouring `.

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