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Senior Economist,
ABN Amro Bank
Fall in the odds of a Fed rate cut would help the greenback
Rupee climbed to a new high against the dollar last week. With a 2.8% rally in BSE-Sensex over the week and the 18,000 peak now seemingly not too far, sentiment towards the rupee remained bullish.
Net purchases of $2.5 billion by FIIs during the week fuelled this sentiment further. Market participants remained highly optimistic about the recent upsurge in the pace of capital inflows, as global investors with renewed risk appetites are chasing higher returns in emerging markets and riskier asset classes.
Over the last week, rupee appreciated by 0.9% against the dollar, after trading in the range of 39.365-39.895.
The RBI and the government on their part are continuing with their efforts to cushion the export sector from losses due to a stronger currency.
The central bank has been heavily intervening in order to slow down the pace of rupee appreciation. The magnitude of dollar buying by the RBI since the Fed rate cut on September 18 has been unprecedented.
Latest RBI data shows that its foreign currency assets went up by $11.4 billion in the week ended September 28. This was the biggest weekly accretion to the foreign exchange reserves and most of this would have been on account of aggressive dollar buying by the RBI.
On last Thursday, however, the central bank started lying low and allowed the rupee-dollar rate to fall below the level of 39.50.
The finance ministry also stepped up its efforts to support the exports sector. The ministry increased the outstanding limit on the bonds issued under the Market Stabilisation Scheme (MSS) by Rs 50,000 crore.
These bonds are serviced by the government and are actively used by the RBI to sterilise rupee liquidity injected in the process of intervention. Thus a higher issuance limit for MSS bonds will enhance RBI’s ability to purchase dollars from the market and keep a check on any build-up of excess funds in the banking system, at the same time.
In addition to an higher MSS limit, the ministry also announced new relief measures for exporters including payment of interest on their EEFC accounts on outstanding balances of upto $1 million for the next one year.
Thus, we are seeing a mix of responses from the authorities in dealing with sharp pick-up in capital inflows. It appears that allowing gradual rupee appreciation is now an integral part of the RBI’s strategy to deal with excess capital inflows.
While the pace of capital flows would continue to support a stronger rupee in the near-term, price action in the international market could help to counter these appreciation pressures.
The Indian unit appreciated against the US dollar last week despite the greenback rising against its major currency peers overseas.
The US dollar edged cautiously higher over the week, as few market participants wanted to extend their short dollar positions in the run-up to the release of the closely-watched US non-farm payrolls data on Friday.
The data lived up to its reputation of being a volatile gauge of job market in the US economy. In September, 1,10,000 jobs were created and more significantly August data was revised to show job gains of 89,000 compared to losses of 4,000 estimated earlier. This unexpectedly strong data showed that the economic activity in the US is still holding up well.
The greenback, however, did not gain much on this data, as its advances were quickly reversed after Merrill Lynch announced that a $4.5 billion write-down related to structured and subprime-backed debt would cause third-quarter losses.
Earlier in the week, on Thursday, the decisions by the European Central Bank and the Bank of England to leave their policy rates unchanged, also helped the greenback.
Over the week, the US dollar gained by 0.9% against the euro, 0.2% against the pound and 1.9% versus the yen. The US payrolls data provided another sell signal for the yen, as hopes were revived that the worst of financial market volatility was over.
The US dollar would gain some more support this week from the changes in the Fed rate cut expectations, after the release of a strong payrolls data. The Fed funds futures market is now pricing in only one rate cut, instead of two, before the end of this year.
And the odds of a rate cut at the end of this month are now down to 50% from over 70%. This week will also provide a better sense on whether the worst is behind the US economy with retail sales, a gauge of consumer spending, and producer prices due for release.
In this backdrop, the dollar could hold its ground and the rupee could see some correction as a result. Otherwise high prices of oil and other commodities would continue to exert some pressure on the rupee.
Even the equities market could see some consolidation after rallying sharply over last fortnight. Overall the rupee-dollar pair could trade in a range of 39.50-39.90 during this week.