Comment

The euro lost nearly 2.5% of its value against the US dollar in a tumultuous week that saw it dip to lows not seen since January as market participants reacted negatively to the outcome of an EU summit the week before last when European leaders unveiled a blueprint for a closer fiscal accord to save the currency. The leaders agreed to move up the creation of the permanent European Stability Mechanism and said the EU will reassess plans to cap the overall lending of the ESM and the temporary rescue fund at €500 billion by March.

The euro fell below the $1.30 mark for the first time since January on Wednesday amid continued jitters over the ability of European politicians to find a credible solution to the region’s sovereign debt crisis. The euro weakened on Friday as Fitch Ratings said it lowered France’s rating outlook and put six other European nations on review for a downgrade. Fitch said a “comprehensive solution” to the crisis is “technically and politically beyond reach.”

The pound sterling benefited from the euro’s weakness, hitting a 10-month high against the single currency earlier in the week. It dipped slightly against the single currency on Friday, but over the week, gained 1.8%. The pound, however, was weaker against the greenback, losing 0.8%.

The Swiss franc rose to a six-week high on Friday, continuing to strengthen against the euro after the Swiss National Bank made no move to raise the level at which it was prepared to buy euros to weaken the franc at its quarterly meeting on Thursday. The euro fell 1.1% against the Swiss franc during the week. The franc, however, fell 1.4% against the US dollar and 0.6% against the pound.

Commodity currencies were ahead on Friday amid a cautious improvement in risk appetite, with Australian, New Zealand and Canadian dollars continuing to claw back losses from earlier in the week. The Australian dollar rose 2.3%, while the New Zealand dollar rose 3% against the US dollar.

Asian currencies strengthened, paring weekly declines, after official data showed jobless claims in the US fell to the lowest level since 2008, buoying the region’s export outlook. Hopes for a recovery in the world’s largest economy increased after Thursday’s data showed US initial jobless claims unexpectedly fell to a three-year low and Federal Reserve gauges of manufacturing in New York and Philadelphia topped estimates.

In the local inter-bank market, the Indian rupee came under renewed depreciation pressure on rising local demand for dollars. The rupee weakened to an all-time low against the greenback by Thursday, prompting further action from the RBI both in terms of direct intervention and control measures. The Indian rupee was one of the biggest gainers on Friday, with 2.7% appreciation, after the central bank announced measures aimed at curbing speculation on the currency and stemming some of the sharp losses against the greenback seen this year.

The RBI also deregulated interest rates on non-resident Indian deposits to attract greater flow of dollars through this route. Over the week, the rupee-dollar pair traded in a wide range of 52.125-54.305 and the rupee weakened by 1.3% over the week.

Going ahead, the US dollar has two significant obstacles that it has overcome to extend this past week’s impressive run — a rising tolerance for financial shocks and expectations for a seasonal slump in participation of speculators. Without an active, global push for risk avoidance, the greenback could spend the remainder of the year in a choppy retracement back into broader ranges.

That said, the market will be looking beyond the two-week, year-end period to project the risk of the euro-area crisis evolving into a global crisis. That forward-looking concern will act to ensure that a dollar unwinding trend would struggle for momentum.

There is a looming and difficult-to-price risk that one of the rating agencies will deliver on threatened downgrades to important members of the EU or the EFSF lending programme. Such a development would further undermine the rescue effort and hasten the spread of financial trouble to the other developed-nation markets. Any significant deterioration in global credit conditions will likely increase volatility in the markets and demand dollar-based safe haven assets. As for fundamental developments in the US, the economic data due this week for release does not carry enough influence to spur anything more than a temporary surge in volatility.

The rupee would continue to trade with a depreciation bias against the US dollar. The greenback can continue to hold on to its strength against major global currencies on account of growing risk aversion around the disappointments in the resolution of the euro-zone debt crisis. That, combined with the fact that Brent crude holds well above $100 per barrel and local stock market conditions look weak, will weigh heavy on the rupee.

All the same, the worst may be more or less behind the rupee for now as the RBI is now showing greater resolve in arresting the pace of rupee depreciation through direct intervention and control measures. The Indian unit could, however, see another round of pressure if there is a dollar liquidity squeeze in the global financial system, or there is a sharp pickup in capital outflows.

Over this week, the rupee-dollar pair can trade in the 52.25-53.50 range.

The writer is senior economist, Royal Bank of Scotland NV and can be reached at gaurav.kapur@rbs.com. Views are personal