Column

Uncertainty prevails in markets in the midst of worsening global economic backdrop even as policymakers, particularly in the US, continue to initiate counter measures.

Last week a slew of data releases showed that real economic activity in major global economies remains depressed, unemployment is rising and credit conditions remain tight.

That raised risk aversion among investors and other market participants. Their appetite for risk had improved earlier in the week on the back of fresh efforts by the US government to stimulate the economy and stabilise the banking system. These changes in risk perception affected the price action in the currency markets. The US dollar and Japanese yen saw high volatility as risk appetite continued to dominate trading in these two currencies. Both currencies weakened sharply in the first half of the week, as equities rallied on hopes that plans of the new US administration would alleviate problems in the global financial system. However, a sharp increase in risk aversion later in the week boosted both currencies. Over the week, the greenback rose 1.3% against the yen and gained 0.4% against the Swiss franc.

Meanwhile, the euro dropped 1.6% against the US dollar over the week, as concerns grew about the health of the euro-zone economy and the European Central Bank’s reaction. ECB president Jean-Claude Trichet suggested that it would not like to cut euro-zone interest rates below a certain level to keep monetary policy headroom in the case of further weakness.

It was, however, the British pound, which outperformed other major currencies last week. It bounced back from multi-year lows against the greenback and the yen, as UK financial stocks recovered some poise. Concerns over the health of the financial system in UK had caused banking stocks to plunge in the week before last. That had triggered a sharp sell-off in the pound, which hit a 23-year low against the US dollar and a record trough against the yen on January 23.

Last week’s rally in UK banking stocks helped boost the pound. It was also supported by comments from George Soros, who made $1 billion in 1992 by selling the pound. Soros said that he had stopped betting against the pound after it reached $1.40 against the dollar. Over the week, the pound rose 5% against the dollar, gained 6.4% against the yen and climbed 6.3% against the euro. In the local inter-bank market, the rupee registered marginal gains against the greenback over the week. The unit finished stronger by 0.8% versus the US dollar after trading in a narrow range of 48.75-49.25.

Month-end demand for dollars from importers and other corporates kept the rupee under pressure. However, a strong performance by the stock market, with an 8.6% jump in the Sensex, helped the rupee strengthen.

The RBI’s decision to keep policy rates unchanged in its quarterly review of the monetary policy also helped bolster the rupee.RBI, after having cut rates aggressively since October last year with the most recent cut of 1% on January 2, decided to adopt a “wait and watch” approach in its policy announcement on Tuesday.The central bank also pointed out that it does not see any problems in retiring of the short-term external debt maturing within one year, which stood at $85 billion at the end of March 2008. This is significant for the rupee especially given that capital inflows remain sluggish.

This week, the focus will be on the macro-economic data releases in the US. The most important of them is the non-farm payrolls report, which is likely to show that the US economy shed over 5,00,000 jobs in January in the manufacturing and services sector. Other data releases like the ISM manufacturing survey report would only reinforce that the fundamental outlook for the US economy remains poor.

However, price action in the currency market would continue to be dominated by risk perception driven capital flows. Risk appetite could improve if the new US administration announces its plan to unlock the credit markets and lower mortgage rates. Any improvement in risk appetite will prove detrimental for the dollar and the yen.

In the local market, rupee is likely to remain range-bound against the US dollar with price action in the pair being driven by the local equity market movements and the greenback’s overall strength. Any beneficial impact of improvement in the global risk appetite on the local stocks, and therefore the rupee, could be countered by worse-than-expected third quarter corporate results.

However, rupee-dollar level of 49.25 could remain a significant resistance for pair on the back of dollar sales by exporters and other market participants around that level. Overall, the rupee-dollar pair could trade in the range of 48.50-49.25 this week with some downside risk.