St has priced in a stronger dollar, gains to be muted

As predicted by this column, the last week saw a breather in US dollar strength. Globally, USD/CNY stopped shy of the 7.00 mark, and the trade weighted US Dollar Index corrected by about 1%. USD/INR showed some stability as well, moving down from a peak of 68.82 the previous week to close at 68.26.

Last week also saw a few significant events, which will have a bearing on markets. The Organisation of Petroleum Exporting Countries (Opec) agreed to its first cut in production in eight years, and non-Opec countries are expected to join in as well. Overall, we could see a significant 2% reduction in global oil production, and oil prices jumped up in response.

On Friday, we also had the US Nonfarm Payroll (NFP) released for the month of November, which showed unemployment in the US dropping to a 9-year low of 4.6%. While there was no pay rise accompanying this data print, a rate hike from the Federal Reserve in this month's meeting is near certain now.

There are other upcoming events this week. By the time this column is printed, the Sunday Italian referendum and the Austrian election would have been completed. Markets are bracing for more populism and inward looking polity, reinforcing the trend since Brexit and the Trump election. Other countries in Europe, such as France in April 2017, could head the same way as well. Besides impacting geopolitics, all this could bring to question global trade and economic growth.

Closer home, we will have the Monetary Policy Committee meet on December 6-7. Bucking global trends in interest rates, we expect the MPC to cut policy rates in India. Believe the short-term demand slowdown arising from demonetization warrants some temporary monetary and fiscal relief.

All the events above point to a stronger USD. However, in the short run, believe the market is well positioned with this expectation, and any immediate further gains in USD strength, including in USD/INR could be muted.

Notwithstanding the short run, the medium-term uncertainty about global growth and trade remains. Parts of the European and Chinese banking systems continue to have vulnerabilities. Large central banks have little room to stave off any more crises.

Given global uncertainty, given rupee is over 16% overvalued in Real Effective Exchange Rate (Reer) terms, given the overhang of unhedged exposures, it would still be prudent to use any corrections to buy insurance in the forex markets.