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SharePositive economic data influenced market action last week triggering a rally in both equities and bonds. Strong data releases included buoyant consumer confidence readings in the eurozone and the US, and better-than-expected US new home sales and durable goods orders data.
Both numbers pointed to a continued warming up of economic activity, while strong investor and consumer confidence measures in the eurozone and the US showed a gathering of economic momentum. The currency market action was largely in line with this environment supportive of improving risk appetite.
Among major currencies, the pound fell to an 11-week low against the euro and to a one-month low against the US dollar, as concerns grew over UK government's finances. The pound already undermined by the Bank of England's surprise decision to increase the size of its quantitative easing programme, suffered as market focus turned towards the rising levels of public debt in UK.
Fears grew over the state of public finances, following planned economic stimulus of £175 billion. According to ratings agency S&P, UK's public debt is set to reach 100% of GDP and could lead to a funding crisis if not managed properly. Over the week, the pound fell 1.4% against the greenback, 1.3% against the euro and 2.2% against the yen.
The yen outperformed its major peers, rising 0.8% against the US dollar and 0.9% against the euro last week.
This was in spite of a relatively upbeat series of global economic data releases. These signs of improvement in data in recent times would normally have stemmed haven demand for the yen.
Expectations that Japan's ruling Liberal Democratic Party would lose its hold on power to the opposition Democratic Party of Japan (DPJ) in the elections boosted the yen. DPJ leader, Yukio Hatoyama, has called for a push towards a single regional currency and said there was a doubt about "the permanence of the dollar as the key global currency".
Rhetoric like this and the DPJ's wish to change the structure of Japan's economy away from dependence on exports are reasons why many expect that the yen will strengthen under a DPJ government. Besides these expectations around elections, low US government bond yields also increased the attractiveness of assets denominated in the Japanese currency.
The US dollar ended the week on a mixed note across the majors, losing against the New Zealand dollar, Australian dollar, and yen, but rising versus the Swiss franc, euro, and pound. The Australian dollar rose 0.7% against the greenback as a surprise rise in second quarter capital expenditure sparked talk that the Reserve Bank of Australia might raise interest rates at its policy meeting this week.
In the local inter-bank market, the rupee finished marginally lower against the US dollar as month-end demand for dollars pushed the Indian unit lower. The rupee was however, supported by a rally in the stock market and net positive inflows from the FIIs. The rupee-dollar pair traded in the range of 48.39-49.05 over the week.
This week has a heavy data release schedule and therefore promises to provide sharp market movements and volatility.
There are a number of important US economic indicators due over this week, which could trigger breakouts for the US dollar.
On Tuesday, the ISM manufacturing index is expected to rise above 50 - the point of neutrality - for the first time since January 2008, which would suggest that the manufacturing sector is finally experiencing a legitimate recovery in business activity. A strong ISM manufacturing reading would bode well for the US dollar.
The main event risk for the greenback will be on Wednesday with the release of the minutes from the Federal Reserve's last meeting on August 12. Following that meeting, the policy statement eventually led to a quick return to risk-taking that pushed the greenback lower, as the Federal Open Market Committee (FOMC) said that the current "policy actions will contribute to a gradual resumption of sustainable economic growth" and that they had decided to gradually slow the pace of Treasury securities purchases.
A reiteration of these statements has the potential to lift risk appetite further, but on the other hand, indications that FOMC members are feeling uneasy about the outlook for growth or the need to expand quantitative easing down the road could do the opposite.
On Thursday, ISM non-manufacturing is anticipated to rise to an 11-month high of 48.0 for the month of August from 46.4.
While stronger readings are always a positive, anything below 50 will continue to signal a further contraction in activity and will ultimately highlight the lack of consumer spending growth in the US.
On Friday, the US non-farm payroll (NFP) report is forecasted to show job losses for the twentieth straight month in August, though the rate of decline is anticipated to slow further.
The NFP result will be the event to watch as it is extremely volatile and is one of the sole reports that impacts the US dollar from a pure fundamental point of view.
In the local market, participants would look for direction from the US data releases. If the data points towards US economy gaining momentum, then further improvement in risk appetite is likely. That could help the local equities market and the rupee, especially if that leads to a pick-up in FII inflows.
Month-end demand for dollars could continue to weigh on the rupee for the first couple of days and any gains would therefore be muted. Overall the rupee-dollar pair could trade in the range of 48.20 - 48.90 this week.
(The author is senior economist, ABN Amro Bank. Views expressed herein are personal. E-mail: gaurav.kapur@in.abnamro.com )
