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A rising tide of optimism lifted stock markets and commodities last week amid growing hopes for an early recovery in the global economy.

A keenly-awaited trial for positive sentiment, the results of the US government’s stress tests, which ordered 10 of the 19 largest US banks to raise a total of $74.6 billion in capital, were widely expected and were broadly welcomed by market participants.

The dollar weakened while commodity-linked currencies rose, as risk appetite continued to strengthen. The greenback had to navigate a week packed with major economic events, including monetary policy decisions from the European Central Bank and the Bank of England, the official results of the US stress tests and April’s US non-farm payroll data.

The ECB cut its main interest rate to 1% and announced plans to buy 60 billion euros of covered bonds in euro-zone companies. The BoE held rates at 0.5% and expanded its government bond purchase programme by £50 billion ($75 billion) to £125 billion.

The greenback dipped on news of continuing job losses and the stress test results. It lost 2.9% against the euro and 2.2% against the pound over the week. The pound was up 0.7% against the euro. The official result of the US stress test was along expected lines. That triggered a move towards riskier assets.

Moreover, the US economy lost 539,000 jobs in April taking unemployment level to 8.9%. The jobless rate is at its highest level since 1983 and payrolls have contracted for 16 consecutive months now, taking the total number of job losses up to 5.74 million since the beginning of 2008.

The high-yield currencies associated with the carry trade were the biggest gainers of last week. The Australian dollar hit a seven-month high against the yen, rising 4.9% last week. The Aussie was up 5.4% against the dollar too. The New Zealand dollar climbed 4.1% against the yen and 4.3% against the greenback.

Emerging market currencies were also boosted by improving risk appetite, which tends to drive investors from safe havens such as the dollar and yen and into riskier assets. The South Korean won hit a six-month high against the yen on Friday, gaining 2.2% against the Japanese currency over the week and 2.7% against the dollar.

In Europe, the Hungarian forint climbed 4.5% against the greenback and 2.8% against the euro over the week. The forint was among the worst performers in central European currencies during the peak of crisis. Elsewhere in Europe, the Czech central bank cut its main interest rate by 0.25% to 1.5%, a new historic low. The koruna gained 1.5% against the dollar on the week.

In the local inter-bank market, the rupee appreciated by 1.2% against the greenback as positive economic data along with rising risk appetite among foreign investors boosted the local stock market.

The ABN Amro India Manufacturing PMI for April printed at 53.3 compared to 49.5
in March, signalling expansion in business activity for the first time since November last year. That helped boost sentiment on hopes the economy is recovering after a period of sharp deterioration in activity. This growing confidence was visible in FII inflows of $937.4 million during the week. The Sensex rose 4.1% during the week as a result, and that in turn, boosted the Indian unit. The rupee-dollar pair traded in the range of 49.21 - 49.95 over the week.

This week, Federal Reserve chairman Ben Bernanke will speak on Monday on the stress tests, and his comments are likely to be market-moving. Comments that reiterate the positive sentiment indicated by the official report have the potential to provide yet another boost to risk appetite, while leading the dollar and yen losses to be exacerbated.

On Wednesday, the US commerce department is forecasted to report that retail sales slipped 0.1% in April, after tumbling 1.2% in March. Excluding autos, retail sales are anticipated to stagnate. However, there is potential for a better-than-expected result, which could further boost risk appetite.

Initial estimates of US first quarter GDP showed that personal consumption rose 2.2% during the quarter, suggesting aggressive discounting by retailers has been able to offset some of the negative impact of deteriorating labour markets, tight credit conditions, and a lingering recession.

In the local market, improvement in the global investor risk sentiment is positive for the rupee. It has manifested in FIIs resuming their purchases of local equities and bonds since April. The dollar’s continuing weakness against other major currencies, particularly the euro, would also prove beneficial for the rupee.

However, rising commodity prices, particularly of oil, negates the favourable impact of the positive global trends. Crude oil prices rose over 12% last week. If this trend persists, it could reverse the improvement seen on the external front in the form of narrowing merchandise trade deficit.

The other risk for the rupee emanates from the outcome of the general elections. Given the uncertainty over the new government, FIIs could look to hold back on further inflows this week. Overall, the rupee-dollar pair could trade in the range of 49.00 - 49.75 this week. Caution among market participants could keep a lid on rupee’s gains.

The author is senior economist, ABN Amro Bank. Views expressed herein are personal.