Bearish dollar momentum favourable for rupee, but gains likely to be muted

Riskier assets hit a post-crisis high last week in the wake of tepid growth figures signaling still-loose monetary policy. A combination of low interest rates and steady but unspectacular growth proved a perfect mix to feed the risk appetite of investors.

Chairman of the US Federal Reserve, Ben Bernanke, gave his first press conference on Wednesday and emphasised that, while the $600 billion quantitative easing programme would end as stated in June, the Fed saw enough weakness in the US economy to suggest that price pressures were “transitory”, and the Fed would not be reducing the size of its enormous balance sheet. This pushed US stocks to their highest level since June 2008, a few months before the collapse of Lehman Brothers. It also propelled commodities, especially precious metals.

In the currency markets, the US dollar continued its decline last week hitting a three-year low after the Fed confirmed market suspicions that it would not be ready to tighten monetary policy for some time.

Extending its run of weekly losses to five, the dollar index, which tracks greenback’s performance against a basket of global currencies, fell 3.8% in April, with 1.5% decline last week. The trade-weighted dollar index has fallen 7.6% in 2011 so far and has not enjoyed a positive month since November.

Following the Fed meeting on Wednesday, first-quarter US GDP data on Thursday did little to counter expectations that the US central bank would continue its easy monetary policy for the foreseeable future. Over the week, the US dollar fell 1.7% versus the Euro and lost 1.2% against the Pound. Against the Australian dollar, a favoured currency for carry trades, the greenback fell 2.1% leaving the Aussie at a 29-year high.

The Swiss franc pushed to a record high against the dollar. Traditionally sought out during periods of uncertainty, the Swiss franc began its ascent at the height of the Euro-zone debt crisis last June. In recent weeks, strong economic data and corporate performances have driven the franc further still. It climbed 2.3% versus the US dollar last week.

One of the best showings over the week was from the Euro. The Euro climbed 0.8% versus the Pound and gained 0.9% against the Yen. The other European major, Sterling rose against the dollar and Yen after data on Wednesday showed that the UK economy had returned to growth. The Pound gained 0.1% against the Yen.

The Japanese Yen lagged after rating agency S&P cut its outlook for Japan’s sovereign debt from “stable” to “negative”. The other major Asian currency, the Chinese Yuan, broke the crucial mark of 6.50 against the greenback, as what is perceived as the Chinese authorities using a stronger currency to curb inflation.

In the local market, rupee appreciated marginally against the US dollar. The gains in the Indian unit were muted by rising dollar demand from the corporate sector, especially oil companies. FIIs also remained on the sidelines and were net sellers of Indian assets by $354 million. Over the week, the rupee-dollar pair traded in the range of 44.21 - 44.62 and the rupee appreciated by 0.3%.

Going into this week, the US Dollar remains a favorite for speculators to go short with record-low interest rates and little risk of Fed rate hikes through the foreseeable future. A busy week for US economic event risk and international central bank rate decisions could nonetheless shape market forecasts for future rate spreads and force major moves across key currency pairs.
Early in the week, ISM Manufacturing and Services, and ADP Employment data should shape sentiment heading into the critical US non-farm payrolls report. Markets expect that Friday’s non-farm payrolls data will show the US non-farm sector added a net 200,000 jobs in April —reflective of modest growth in employment. Any significant upward surprises could have similar effect on Fed rate expectations. The risks arguably remain to the upside for the US dollar ahead of this release. Any significant deterioration in Fed rate expectations on a disappointment in the employment data is unlikely, while above-consensus forecast results could bolster Fed rate expectations.

Market participants will also look to European Central Bank (ECB), Bank of England, and Reserve Bank of Australia interest rate decisions to potentially shift interest rate expectations. Overnight Index Swaps predict that the Fed will raise interest rates by a paltry 0.3% in the coming 12 months. ECB predictions stand at a relatively robust 0.75% and the prospect of widening rate differentials has without a doubt boosted the Euro in recent weeks. All three banks are expected to leave rates unchanged, but markets will monitor post-announcement rhetoric from each the ECB, BoE, and RBA for direction on future decisions.

Sharp downward momentum and bearish market sentiment leaves the greenback prone to further downside through this week. If the equity markets and other key ‘risk’ barometers continue their rally, the US Dollar can be expected to move lower.

Yet market participants would keep a close eye on risk appetite in a pivotal week. Heavily one-sided US Dollar short positions suggest that the greenback could gain substantially on any risk aversion driven deleveraging across global financial markets.

In the local inter-bank market, besides the crucial global events, the focus will also be on the annual monetary policy announcement by the RBI on Tuesday. The central bank is widely expected to raise rates by 0.25% in order to curb the inflationary pressures. Market would also look for guidance on growth and inflation in this fiscal year from the central bank.

Another 0.50-75% of rate hikes are priced in already. If post policy expectations drift towards greater monetary tightening, it would be negative for the stock markets and in turn the rupee. Otherwise US dollar weakness and strong risk appetite are positive for the rupee. But rising oil and gold prices would continue to put rupee under pressure and keep gains muted. Over the week, the rupee-dollar pair can trade in the range of 44.00 - 44.50.

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