Dollar's movement overseas will set the tone for rupee

Sentiment recovered on guarded optimism that policymakers would contain the Greek crisis and gains on Friday ensured global equities had their first positive week in a month.
In the currency markets, the euro had a volatile week but still managed to record gains against the US dollar as risk appetite began to pick up towards the end of the week and drove the greenback lower.

Disappointing update on first-quarter US growth on Thursday and evidence of weaker consumer spending underlined the notion that the world’s biggest economy was still a long way from tightening its monetary policy. Market participants, who had sought the safe haven of the US dollar earlier in the week following the fallout from the euro zone debt crisis, soon became sellers of the greenback.

Rating agency Standard & Poor’s warned on Italian debt and concerns surrounding possible Greek debt restructuring. After a warning from the chief of the euro group finance ministers, Jean-Claude Juncker, that the IMF would delay further aid to Greece if it wasn’t convinced by budget reforms, the noise surrounding debt crisis in Europe’s periphery quietened during the G8 meeting on Friday. News that Greek Prime Minister George Papandreou was to meet opposition leaders in a bid to achieve consensus on fiscal measures helped calm the euro zone related market jitters.

Market participants turned their attention back to economic fundamentals in the US and found them lacking. Investors were disappointed that the second reading of US growth data had not shown upward revisions to the initial estimate of 1.8% GDP growth in the first quarter.

The euro climbed 1.2% over the week versus the US dollar, managing to rise off a one-month low. It remained largely unchanged against the yen, and fell 0.5% versus the pound. The euro, having hit a record low against the Swiss franc, fell a further 2% over the week.
Sterling’s strong performance against the greenback came against the backdrop of Wednesday’s second reading of UK GDP data that confirmed the initial estimate of 0.5% quarter on quarter growth. The pound rose 1.7% over the week against the US dollar and gained 0.6% against the yen.

The yen also appreciated against the greenback last week, helped by Friday’s data that showed core consumer prices turned positive for the first time since February 2009. The yen gained 1.1% during the week against the US dollar. The Swiss franc emerged as the week’s star performer, hitting record highs against the US dollar and the euro, as investors flocked to the haven currency. The franc gained 3.2% against the greenback.
In the local market, rupee continued to weaken against the US dollar. Falling stock market and recovery in global crude oil prices added to the downward pressure on the rupee. The strength of the US dollar overseas was the primary source of rupee weakness. The Indian unit recovered a tad on Friday. Over the week, the rupee-dollar pair traded in the range of 45.12 - 45.4275 and the rupee weakened 0.4% against the US dollar.
The greenback remains plagued by its exceptionally loose monetary policy, which keeps it on the short side of riskier market positions. There is a direct fundamental link to risk appetite trends where balanced markets encourage market participants to seek out riskier assets with higher return and invest in them by borrowing in dollars.

There are only two scenarios in which the greenback can stage a meaningful recovery. The most immediate and also fleeting in nature is a shift in risk appetite trends. Market participants will therefore keep an eye on capital markets, especially equity markets.

The eventual rebound in rates for the US will have a greater influence in lifting the dollar. That however, would take more time to gain traction. The timing for the Fed to start withdrawing monetary stimulus and the markets’ effort to pre-empt the move are difficult to discern. The QE2 is expected to end in June. And though it is unlikely that the Fed policy makers will immediately withdrawal stimulus, the market will certainly price in the effects the eventual move will have.

In the meantime, market participants will keep an eye on definable events that can help make some progress on these larger themes or otherwise trigger short-term bouts of volatility. In the week ahead, we have the most watched data release —- the US non-farm payrolls report. Expectations for this indicator’s influence should be tamed, however, as there has been little lasting impact from recent releases. If the market is already moving before the release, this data can amplify that move. At the start of the week, the US Memorial Day holiday will act to dampen meaningful moves.

In the local market, rupee can remain under pressure against the US dollar. Market participants would keep a close watch on the events in the euro zone, shifts in global investor risk appetite and the local stock market conditions. Any weakness in the local equities will put pressure on the rupee. Movement of the US dollar overseas will, however, be the primary driver of the rupee. Over the week, the rupee-dollar pair will trade in the range of 45.00-45.50.

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