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ShareThe dollar strengthened further last week as it continued its domination over other currencies. The European majors, euro and pound, took the most beating.
Weakening growth outlook in the Eurozone and the UK was behind the dismal performance of their currencies. The rupee also slipped further against the greenback to levels last seen in March 2007.
The dollar maintained its recent strong run, hitting a fresh six-month high against the euro. The greenback gave back some of its gains later in the week, but still stood 0.8% higher at the weekly close.
Macroeconomic data favoured the greenback. The second-quarter US GDP growth was revised up sharply, largely because of strong exports. On the other hand, the IFO index of German business sentiment reported its worst results in three years. Over the month of August, the dollar rose 5.9% against the euro, its strongest monthly rise since the creation of the single currency in 1999.
The pound also continued to underperform its peers as evidence mounted that the UK economy was headed for a recession.
After a string of weak data releases earlier this month, pound's woes were compounded as data showed house prices in UK fell at their fastest pace since 1991 in August. More importantly, retail sales -- an important gauge of the strength of consumer spending -- plunged to their lowest level in 25 years.
This raised expectations that the Bank of England, which holdsits monetary policy meeting this week, would cut interest rates. On Friday, the pound dropped to its weakest level in two years against the greenback, taking its losses over the week to 1.7%.
In August, the pound lost more than 8% against the greenback, its worst monthly performance since its ejection from the European Exchange Rate Mechanism in September 1992.
Trade-weighted value of the pound against the currencies of the UK's leading trading partners, dropped to a 12-year low.
While the greenback rose rapidly against the European majors, it lost ground against the Asian major, the yen. It eased 1.2% against the currency, as data showed Japanese consumer spending and industrial production rose by more than expected in July. The data raised hopes of a rebound from the economic contraction seen in the second quarter. Also on Friday, the Japanese government announced a $107 billion fiscal stimulus package for the economy, which includes tax cuts and larger government-guaranteed loans.
The yen also rose 2.8% over the week against the pound and gained 1.9% against the euro, making it the outperformer among the major currencies last week.
In the local market, the rupee depreciated by 1.2% against the dollar to take its total losses to 3.2% in August. The Indian unit came under intense pressure due to both fundamental and technical factors. Banks facing a cash dollar shortage and noting the dollar strength entered into buy/sell swaps between spot and forward markets. Even the RBI was seen doing these swaps in the near months.
That pushed the value of the spot rupee-dollar to above 44 during intra-day trading last Tuesday. The central bank, however, stepped in and sold dollars to pull the rupee-dollar rate back below the 44 level.
The demand for dollars was also quite strong. Month-end demand from oil companies added to the dollar buying from other importers.
The market largely ignoredthe GDP data as 7.9% was in line with market expectations. It was the slowest growth in three-and-a-half years.
This, along with a marginal decline in WPI inflation, bolstered expectations the RBI might not tighten monetary policy further.
A stock market rally on Friday helped the rupee to some extent,but RBI had to continue its intervention, noting strong dollardemand. Over the week the rupee-dollar pair traded in a range of 43.40-44.14.In the forwards market, the buy/sell swaps pulled down the forward premia across the curve.
The decline was particularly sharp in the overnight tenor and for the near-months, as banks bought spot dollars and sold them back in these forward tenors.
Last week saw an important development for the market, with the introduction of the currency futures on the NSE. This new instrument would help in providing more liquidity and depth to the market and will help in better price discovery. The end-September contract saw the most trading volume and the one month rupee-dollar future ended at 44.02/$.
This week, market participants will have to reassess their recent dollar bullishness, as crucial data releases are due from the US economy. The most important of them, the labour market data will have a greater influence on the fundamental outlook on the US economy and the greenback than usual.
This time around, the leading economic indicator will be measured against last week's strong GDP revision and the hawkish comments by the FOMC.
If, as expected, non-farm payrolls contract for the eighth consecutive month, the market would have to review its positive outlook for growth through the second half.
Considering the fact that 3.1% of the 3.3% pace of growth was on account of exports, there is clearly room for scepticism about activity in the second half. As unemployment continues to rise, consumer spending (accounting for 70% of the US GDP) will add huge weight to the housing recession.
Before the non-farm payrolls report, the combination of the ISM's manufacturing and service sector activity reports will provide evidence on the economic activity. And considering both sectors are steeped in a long-term downtrend, the outlook is not promising. Thus, it appears the greenback could be under pressure for fundamental reasons this week.
A downward correction in the dollar would be helpful for the rupee. Even otherwise some FDI related inflows are expected to hit the market over the next couple of weeks. The rupee could trade in the range of 43.20-43.80 against the greenback, but weakening bias would persist.
(The author is senior economist, ABN Amro Bank. Views expressed herein are personal. E-mail:
gaurav.kapur@in.abnamro.com)
