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Financial markets continue to be buffeted by strong headwinds challenging risk appetite. Worries over further monetary tightening from China, proposals from US President Barack Obama to rein in activities of US banks and continued concerns over the fiscal situation in Greece, all raised concerns about the sustainability of speculative asset market rallies and prompted a sell-off in global equities.

With China announcing its intentions to cool its economy and markets and US President Obama proposing a limit on the size and risk-taking activity of the nation’s largest banks, the world’s largest governments are taking an active role in slowing speculative positioning.

While all three issues added considerably to the uncertainty about the prospects of the global economy, the possibility of a serious restriction of Chinese credit was the most important factor. Possibility of further monetary tightening in China arose on Thursday after Chinese fourth-quarter growth and December inflation data both came in well above forecasts.

A loose monetary policy stance globally has been successful in steering the global economy away from a depression. But this monetary stimulus would be gradually withdrawn in order to keep inflation in check. Monetary tightening could slow the pace of growth and would certainly curb the asset-price inflation. This is likely to keep investor’s appetite for risk subdued.

In the currency market, the US dollar and the Japanese yen rose last week as low risk appetite boosted demand for both these safe-haven currencies. Both the greenback and the yen have been widely sold to fund the purchase of riskier, higher-yielding assets.

The yen finished the week at the top in terms of weekly gains. Its advance was sharpest against commodity-linked currencies, which were hit hard by the prospect of falling Chinese demand for raw materials. Over the week, the yen rose 3.4% against the Australian dollar, climbed 3.7% against the Canadian dollar and gained 4.6% against the New Zealand dollar. The yen also rose 1.9% against the pound and climbed 1% against the US dollar over the week. The greenback made progress elsewhere, up 1% against the pound and 1.5% against the Swiss franc.

Meanwhile, the euro slumped to a nine-month low against the yen and dropped to its lowest level in five months against the US dollar and the pound, as worries over the fiscal situation in Greece continued to have a negative impact on the single currency.
The spread of the 10-year Greek government bond yield over its German counterpart rose to its highest level since Greece joined the eurozone in 2001, sparking some fears that Greece’s budget troubles might force its expulsion from the single currency regime.

Over the week the Euro fell 2.7% against the Yen.

In the local inter-bank market, the rupee depreciated against the US dollar.

Dwindling equity markets and dollar strength overseas pushed the Indian unit beyond the 46 level for the first time in two weeks. The BSE Sensex fell by close 4% over the week as mixed corporate results and low investor risk appetite pulled it down.

FIIs remained net buyers of local stocks and bonds, but their purchase was relatively lower compared with their activity in recent weeks.

Over the week the rupee-dollar pair traded in the range of 45.54 -46.27 and Indian unit depreciated by 0.8% against the greenback.
This week, the economic release docket holds a slew of important data releases from the US. The most critical piece of data is the advanced reading of fourth quarter US GDP due on Friday.

Considering this is a release for the end of the week, it could actually work to anchor the US dollar, as market participants would avoid making significant changes to their positions before such a meaningful report. This indicator will have a fundamental influence on the greenback.

A strong pace of expansion in economic activity would help in establishing US dollar’s relative strength against it counterparts. It could also play a role in driving risk appetite.

As the largest economy in the world, a strong pace of expansion in the US could bolster the outlook for global activity and help boost risk appetite. There are many other indicators that will weigh on market sentiment as well. These include consumer confidence, durable goods orders and existing home sales. The most important event of the week would be the US Federal Reserve’s rate decision due over January 26 and 27.

As usual, the Fed’s assessment of the economy and any indications of a normalisation of monetary policy would be closely watched. It appears that the greenback can very well hold off to its position of strength this week, given the slew of important data and events.

Local market action would continue to be driven by the price action in the US dollar overseas.Among key events that could have some bearing on the rupee is the quarterly review announcement of the monetary policy by the Reserve Bank of India (RBI) on the January 29.

The central bank is widely expected to take the first step towards monetary tightening.

The market has priced in a 25-50 bps increase in the cash reserve ratio by the RBI in order to withdraw liquidity in order to curb inflationary expectations.

Some sections of the market are expecting more aggressive action in the way of policy rates hikes. The central bank may however, choose to be more gradual in approach.

The market will also pay special attention to the stance of the central bank and its assessment of the growth and inflationary conditions.

An optimistic assessment of growth by the RBI may not be too helpful for equities, as that would also mean much sharper monetary tightening in future.

Overall, the rupee would continue to trade with a weakening bias against the US dollar. The rupee-dollar pair can trade in the range of 45.80-46.25 this week.

The author is senior economist, ABN Amro Bank.