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The appetite for risk got a boost last week on the back of fresh measures by the US Federal Reserve to fight the credit crisis and a particularly large rate cut by the Chinese central bank, the PBOC. The Fed on Tuesday announced that it would purchase up to $600 billion of mortgage debt backed by the US government housing finance agencies.
It also announced that it would set up a $200-billion facility to support consumer and small business loans. Separately, the US government announced a $306-billion support package for the Citigroup.
On Wednesday, the PBOC announced a 1.08% cut in deposit and lending rates. This
was a big move considering that the Chinese central bank usually cuts rates by 0.27%. These developments helped revive the risk-taking appetite among investors to some extent. As a result, the equity markets across the globe saw a rally last week.
In the currency market, the US dollar came under pressure. The announcement of new measures raised fears over the US government’s rising indebtedness. A rally in global equity markets also put pressure on the greenback, lessening safe-haven demand for the currency.
The quantitative easing approach to monetary policy — where the target is the quantity of money rather than its price (interest rates) —being adopted by the Fed also weighed on the US dollar. The Fed is rapidly expanding its balance sheet (and therefore the supply of dollars) to kick-start the stalled credit disbursement mechanism. The Fed’s balance sheet has, as a result, grown from $900 billion just three months ago to $2,200 billion now. The Bank of Japan also followed the same approach to monetary policy in the early years of this decade to push the Japanese economy out of a prolonged recession. That gave rise to the famous yen carry trade.
Over the week, the US dollar fell 0.9% against the euro and lost 3.4% against the pound. Its losses were much less against the yen, down 0.4%. Like the greenback, the low-yielding yen has attracted safe-haven inflows during the turbulence in financial markets. With tensions easing, the yen duly lost ground, falling 0.5% against the euro over the week, dropping 3.5% against the Australian dollar and losing 3% against the pound.
In the local market, the rupee saw a rather calm week. Unlike the recent weeks, where the rupee-dollar pair traded in wider ranges and saw heightened volatility, last week saw the pair trade in relatively narrow range of 49.25-50.25. The rupee finished the week almost unchanged from its previous week’s closing level. In the early half of the week, the rupee gained from the bounce in the stock market and dollar sales by exporters.
Market participants ignored the somewhat better-than-expected GDP data released on Friday. The Indian economy grew at a real rate of 7.6% y-o-y during the July-September 2008 quarter, compared with 7.9% in the previous quarter. A more significant slowdown in growth is likely in the third quarter. That is when the global financial turmoil-driven local liquidity crisis started to adversely affect economic activity in both manufacturing and services sector. Shrinking external demand in the backdrop of recession in most of the developed world has added to the local demand slowdown seen since October. A dip in growth during the second half of this fiscal has been factored in by the market. The market consensus view is of 7% growth for the whole of this year. Any evidence suggesting a worse economic performance could add to the pressure on the rupee in the medium term.
This week, the focus will be on the heavy US data release calendar. On Monday, the ISM Manufacturing Index is forecasted to slip to a fresh 16-year low of 37.5 from 38.9, and would also mark the fourth straight month that the index held below 50, signalling a contraction in business activity. On Wednesday, the ISM Non-Manufacturing Index is forecasted to drop to a new record low of 42.0 from 44.4, which will only add to speculation that fourth quarter GDP growth will also be negative just like the previous quarter. And, the US non-farm payrolls on Friday are sure to garner significant attention from the market as they are forecasted to fall for the eleventh straight month and by the most since September 2001. Further, the unemployment rate is anticipated to rise to 6.8% — the highest since August 1993 — from already high level of 6.5%.
Given the important data release, the greenback will face a lot of event risk. And, with most of the data painting a gloomy picture of the US economy, the greenback could be under some pressure this week too. That will be helpful in providing some support to the rupee. Otherwise, the RBI decision to extend the tenure of its rupee-dollar swap window for Indian banks with foreign branches and other liquidity enhancement and credit flow measures announced on Friday, will help overall market sentiment. The RBI will also look to curb any volatility in the rupee-dollar pair, if there is some pressure on the currency on flight of capital in the aftermath of the recent incidents in Mumbai. The equity market could also get some support from the global rally last week, which too shall prove helpful in containing the downward pressure on the rupee.
Another development which is positive for the rupee is the resumption of the special market operations with oil companies by the RBI last week. These operations are aimed at meeting the oil companies’ demand for dollars out of the inter-bank market.
The RBI sells them dollars directly and in order to provide oil companies’ rupee funds to buy dollars, the central bank buys the oil bonds held by these companies. Between June and July, the RBI sold $15.3 billion to the oil marketing companies under these special market operations. Resumption of these operations will help reduce the pressure on the rupee created by the dollar demand from oil companies. The rupee-dollar pair could thus trade in the range of 49.50-50.50 this week.
(The author is senior economist, ABN Amro Bank. Views expressed herein are personal. E-mail: gaurav.kapur@in.abnamro.com)