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ShareCaution prevailed in the markets last week as the debate over recovery prospects of the global economy weighed on the sentiment. Economic data suggested that the recession's grip was loosening, but expectations for a sharper rebound in the coming months were toned down.
There was some sign of stabilisation in the US labour and housing markets, but industrial production slumped. In the eurozone, Germany's ZEW Research Institute's economic expectations index jumped to its highest level since mid-2006. Equity markets, in particular felt the pressure of this cautious sentiment. Many equity markets around the world registered their first weekly decline in a month.
In the currency markets, the euro lost ground last week, as worries over health of the eurozone banking system weighed on the single currency. The European Central Bank (ECB) warned that banks in the region might face another $283 billion of losses by the end of next year. This week's auction of one-year funds by the ECB was also seen hitting demand for the euro.
Long-term funding in euros could put pressure on the single currency as bank convert the ECB funds into other currencies. Moreover, it is not only the eurozone banks that have access to the ECB's facilities, but also the branches of foreign banks operating in the eurozone.
Some of the liquidity that the ECB makes available could leak out of the region as branches shift some funds secured in the tender. Over the week, the euro lost 0.6% against the US dollar, 2.7% against the yen and 1.8% to against the pound.
Meanwhile, the US dollar was buffeted by seemingly conflicting comments from Russia over its status as a reserve currency. The greenback rallied strongly, ahead of the BRIC (Brazil, Russia, India and China) group meeting in the Russia on Tuesday, after Russian finance minister Alexei Kudrin allayed fears about diversification away from the dollar.
He said there was "no alternative" to the US dollar as a reserve currency and Russia had confidence that the currency was in "good shape". But the greenback suffered after Russia's president Dimitry Medvedev said there was a need to "consolidate" the international monetary system.
The US dollar was hit further on Friday after international ratings agency Moody's placed California's credit rating on watch for a multi-notch downgrade. Over the week, the greenback fell 2.2% against the yen and lost 0.4% against the pound.
The US dollar was flat on the week against the Swiss franc, which saw heightened volatility. It rose to a three-month high against the euro after the Swiss National Bank (SNB) declared that intervention to stem the currency's strength had been successful on Thursday.
This prompted market participants to test the SNB's tolerance, pushing the Swiss franc up to its strongest level since the central bank intervened to halt currency appreciation in March. But the Swiss franc fell sharply on speculation that the SNB had re-entered the market to sell the currency against euro later in the session. This left Swiss franc lower against the euro over the week.
In the local inter-bank market, the rupee slipped by close to 1% versus the dollar, as the market saw its first weekly decline since early March. The Sensex fell by 4.7% over the week.
Even FIIs, who have been actively buying local stocks and bonds, turned net sellers last week. Demand for dollars by importers weighed on the rupee, too. The US dollar's strong performance against the euro also kept rupee under pressure.
Market participants ignored the fact that the WPI based inflation slipped below zero for the first time since 1977. Markets were anticipating a negative print for the WPI-based inflation rate, and considering that inflationary pressures are still quiet strong, chose to ignore the data point. Overall the rupee-dollar pair traded in the range of 47.69-48.32.
In the backdrop of caution among market participants, this week's US data releases and events hold particular significance. The key event of the week will be the meeting of the Federal Open Market Committee (FOMC) on Wednesday. This rate-setting committee is widely expected to leave the Fed funds target range at 0-0.25%. The FOMC has been saying since January that they continue "to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time". Furthermore, the last statement highlighted that the committee's policy focus is to support the functioning of financial markets through quantitative easing and other measures. As long as similar kinds of statements are made by the FOMC, the event shouldn't be too market-moving.
On Thursday, the third and final round of US Q1 2009 GDP estimate is due. The data could be market-moving if it misses expectations. Consensus market forecasts is for GDP growth to remain unrevised at -5.7%, which marks an improvement against the Q4 2008 growth of -6.3%. However, if Q1 GDP growth is revised higher, the news would provide a boost to risk appetite as it would make the US economy appear in a better position to stage a recovery later the year. On the other hand, downward revisions would have the potential to dent risk appetite and take equities lower.
In the local market, rupee could continue to remain under pressure. With global investors looking to consolidate their recent gains, portfolio flows may remain subdued. Any contraction in risk appetite due to weak economic data is likely to hit the local equities further. Therefore, the Indian unit could continue to trade with a depreciation bias this week with a possible range of 47.75-48.50.
The author is senior economist, ABN Amro Bank. Views expressed herein are personal. E-mail: gaurav.kapur@in.abnamro.com
