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ShareLarger than 0.75% cut by US Fed would sink the dollar further
The fortunes of the US dollar continue to dwindle. The greenback plunged to new lows against many of its major counterparts last week. However, the most significant weakening of the dollar was seen against the carry trade currencies -- Japanese yen and the Swiss franc.
In fact for the first time, the Swiss franc appreciated beyond parity against the greenback. The yen also appreciated past the 100 yens-to-a-dollar mark, for the first time since 1995.
Such price action was driven by more news of trouble in the US financial sector and dismal data adding to the evidence that the US economy is headed towards recession.
However, there was some relief for the beleaguered dollar on Tuesday, after the US Federal Reserve announced plans to inject liquidity into the financial system in an effort to smoothen the liquidity shortage generated by the credit crisis.
The greenback rallied as market participants reasoned that the dollar liquidity injection would mean that the Fed would not have to cut rates aggressively at its next monetary policy meeting due this week.
But the euphoria quickly died down as the notion took hold that the move was a complement to, rather than a substitute for, further monetary easing by the Fed.
Also, the fact that investors now had direct access to dollar liquidity from the Fed, hastened the currency's decline.
Otherwise financial institutions were borrowing in other currencies and converting them to dollars; in order meet their cash needs. The greenback's fall gathered more speed on Thursday, as a surprise fall in February retail sales and the news of a hedge fund default further undermined the currency.
The dollar was knocked down more on Friday after the Fed revealed that it was rescuing Bear Stearns, the US investment bank.
The greenback dropped to a 12-year against the yen, taking its losses over the week to 3.7%. The dollar also fell 2.1% to a record low against the euro and broke through parity against the Swiss franc for the first time, falling 2.7%. The greenback also lost 0.2% against the pound over the week and fell 1.1% against the Australian dollar.
Meanwhile, the low-yielding currencies advanced across-the-board, as market turmoil squeezed risk appetite. The yen rose 1.6% against the euro, 3.5% against the pound and 2.6% against the Australian dollar over the week. The Swiss franc was also in demand, rising 0.6% against the Euro on the week and climbing 2.5% against the pound.
In the local inter-bank market, the rupee eked out small gains against the US dollar too. Supply of dollars improved as exporters sold dollars and banks' reduced their positions.
The dollar shortage seen in the market over past few weeks also dissipated. This crunch for cash dollars had driven the spot rate of the rupee higher and forward premiums lower.
Therefore an improvement in cash dollar supply helped reduce the pressure on the rupee. Demand from importers, particularly oil companies, however, kept a check on the Indian unit. The FIIs also remained net sellers of local financial assets, adding to the demand for dollars.
The sentiment towards the Indian currency remained weak, as the stock market continued its slide and price of the Indian crude oil basket crossed $100 per barrel.
Over the week, the rupee-dollar pair traded in a range of 40.28 - 40.712 and the rupee rose by about 0.2% against the greenback. The Indian unit, however, slid sharply against the other majors, particularly the euro and the yen, following those currencies handsome gains against the dollar.
This week the market focus will be on the Fed's rate decision due on March 18. The Fed funds futures have fully priced in a 0.75% cut along with a 60% chance of a full one percentage point cut in the overnight Fed funds rate.
Market participants are of the view that two months' of job losses, a decline in retail sales and static consumer price inflation could push the Fed to administer a strong dose of monetary stimulus to the US economy. If the Fed, however, disappoints the market and cuts by 0.5% only, then the US dollar could recover some ground.
Otherwise, the greenback seems doomed to head towards lower levels. In fact market participants are now speculating about intervention by the European Central Bank and the Bank of Japan to arrest the pace of appreciation of their currencies. The Fed's assessment of the health of the US economy would also be very critical.
In the local market, the rupee could find some support from the possibility of a liquidity squeeze, following the outflow of advance taxes on March 15 from the banking system.
If the banks' are strapped for rupee funds, they could resort to sell-buy swaps between the spot and forwards market. That would increase the supply of dollars in the spot market and push up the forward premiums. The rupee would also receive some support, if the equity market rallies on the Fed rate cut.
Otherwise, spiralling commodity prices, particularly crude oil and gold, would hold the rupee down. In this holiday shortened week, the rupee-dollar pair could trade in the range of 40.20 - 40.60.
The author is India economist, ABN Amro Bank. Views expressed herein are personal.
E-mail: gaurav.kapur@in.abnamro.com
