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Equity markets likely to remain jittery this week

Risk aversion is likely to make a come back this week and investors across the globe would actively unwind carry trades. Such action was already underway after the US job market data released on Friday showed 4,000 job losses in the economy in the month of August. This was the first negative number in four years and took everyone by surprise considering that the consensus estimate was for net additions to jobs by 1,12,000. Figures from previous months were also revised downwards.

Equity markets in the US and Europe slumped following the release of these numbers as this data underlined the risk of subprime-related housing market troubles spreading into the rest of the US economy. Asian equity markets will also feel the heat of a market meltdown elsewhere.

Weakness is the US labour market has now made a rate cut by the Federal Reserve (Fed) on September 18 a foregone conclusion. But that too might not help improve investor sentiment as a 0.25% cut is already factored in. Moreover, considering that the recent spate of weak US data relates to a period before the credit crisis took hold, the risk of US economy losing steam remains high. Therefore, the mood of pessimism is likely to persist in the run-up to the Fed’s monetary policy meeting and investors are likely to remain nervous.

In the backdrop of risk aversion, local equities market could see some exodus by FIIs.

They have been net buyers of Indian equities and bonds for two consecutive weeks now. Net purchases by the FIIs amounted to $893 million last week and that helped the rupee gain value and finish the week stronger against the US dollar. This week, however, FIIs could be forced to sell Indian stocks again in order to cover their losses in other markets and asset classes. That would put the rupee under pressure by increasing the demand of dollars.

Even otherwise, high oil prices would continue to impinge on the rupee. Last week, a 3.7% rise in the WTI oil price saw oil companies mopping dollars aggressively thereby putting a check on rupee’s ascent driven by capital inflows. The rupee-dollar pair traded in a relatively narrower range of 40.66-40.98 last week and the Indian unit appreciated by 0.65% versus the greenback over the week.

While oil prices and weakness in the stock market would push the rupee down over this week, dollar sales by exporters and overseas fragility of the US dollar will cushion the downward pressure to some extent.

The rupee-dollar pair is likely to trade in the range 40.85-41.35 this week, with a bias for the rupee to weaken. The pair would continue to see heightened volatility following the jitteriness in the stock market. The movement in the rupee-dollar rate have to a large extent been driven by the equity market action over the past few weeks.

In the international market, price action in a scenario where risk is being offloaded would benefit the Japanese yen while the greenback could be in for some more weakness against other major currencies.

A key US data release, retail sales, an important gauge of consumer spending, is due this week. Any underperformance in this data would only reinforce the mood of risk aversion and hurt the greenback even more.

Stronger-than-expected data, on the other hand, is likely to be downplayed considering that labour market weakness would affect consumer spending in the coming months.

Last week the greenback crashed as data continued to point towards a slowdown in the US economy. The bearish sentiment towards the US dollar manifested itself during the week after a plunge in home sales was reported on Wednesday. The non-farm payrolls data added to this sentiment.

Over the week, the greenback lost value against the European majors, and finished the week close to a record low against the euro. It, however, depreciated the most against the yen, which emerged at the top among major currencies.

The yen, which has been widely used for funding carry trades in which low-yielding currencies are sold to finance the purchase of riskier assets elsewhere, rose 1.1% against the euro over the week. It climbed 1.4% against the pound and jumped 3.8% against the New Zealand dollar. The euro was supported as the European Central Bank (ECB) maintained its hawkish bias on interest rates.

The ECB kept interest rates on hold at 4% on Thursday, blaming the turbulence in financial markets, but said it still saw upside risks to inflation. Jean-Claude Trichet, ECB president, continued to call monetary policy accommodative and referred to vigorous monetary and credit growth in the euro-zone. This helped the euro gain against the pound Sterling over the week.

Sterling lost ground, as Bank of England, after leaving interest rates on hold at 5.75% on Thursday, released a statement explaining its lack of action, which was taken to be a dovish sign.

Views expressed herein are personal.

gaurav.kapur@ in.abnamro.com