Rupee to remain on a weak ground as stock-market pressures weigh

Financial markets witnessed strong optimism on growth prospects driving risky assets and investor risk appetite higher last week.

Global equities climbed to a 30-month peak with robust manufacturing and services data outweighing a week of political turmoil in Egypt. A mixed US jobs report also failed to deflate market optimism for growth. 

The US manufacturing activity reported its strongest reading since 2004 in January. Notably, the employment component of US Institute for Supply Management report reached its highest levels since the 1970s.

Market participants were also encouraged by purchasing managers’ surveys from the Euro-zone and Asia that pointed to robust recovery and growth.

The market momentum withstood weaker-than-expected US headline non-farm payroll figures on Friday. Employers added only 36,000 more jobs in January, way below the consensus forecast of 145,000.

Market participants however, focused on the surprise drop in the US unemployment rate from 9.4% to 9%.

Market sentiment was also buoyed by key central bankers’ signaling that interest rate rises were some time away.

Comments on Thursday by European Central Bank (ECB) President Jean-Claude Trichet and Ben Bernanke, Federal Reserve chairman, had the effect of distancing both central banks from interest rate hikes.

In the currency market, Euro bulls were disappointed by Mr Trichet not signaling a near-term rise in interest rates. This had an immediate effect on the Euro, which tumbled the most in two months against the US dollar on Thursday.

The Euro fell sharply from a three-month high against the greenback after ECB President, tempered expectations of a near-term rise in Euro-zone interest rates following
the ECB’s policy meeting on Thursday.

This disappointed the section of the market betting that ECB would strike a more hawkish tone given that recent Euro-zone consumer price inflation data had come in above the ECB’s 2% target rate.

The Euro, which touched a 3-month high against the greenback on Wednesday, fell to stand down 0.2% over the week. The dollar index rallied at the end of the week to pare early losses, gains fed by the strong US data.

The other European major, the British Pound surged to a three-month high against the US dollar as market participants raised their bets on a near-term rise in UK interest rates. Interest rate markets moved to price in a 75% chance that the Bank of England (BOE) would raise rates in May, up from just 30% at the start of the year.

Expectations that the BOE would abandon its ultra-loose monetary policy stance in an effort to stem inflationary pressures in the British economy were heightened as surveys revealed a sharp rebound in activity

in the UK manufacturing, services and construction sectors in January. These forecast-beating data fed the notion that the shock contraction in the UK economy in the fourth quarter of 2010 was a one-off and dispelled some fears over stagflation (rising inflation and unemployment) in British economy.

On Thursday, the Pound touched its strongest level since November 5 against the greenback, before easing to stand up 1.5% over the week.  Sterling also climbed 1.7% against the Euro over the week and advanced 1.6% against the Yen.

Elsewhere, commodity-linked currencies found support as the ongoing turmoil in Egypt boosted raw materials prices. The Australian dollar climbed 2% against the US dollar over the week, and the Canadian dollar rose 1%.

In the local inter-bank market, rupee gained value against the greenback over the week. Weakness in the US dollar for most of the week helped rupee recover. However, stock market remained under pressure and foreign portfolio players remained net sellers over the week.

The external commercial borrowings data for December was encouraging as it showed that capital inflows from this route are picking up.

Over the week, the rupee-dollar pair traded in the range of 45.535 - 46.01 and the rupee appreciated by 0.4% against the US dollar.
Going forward, it may be difficult for the US dollar to sustain its rally if market sentiment does not start to deteriorate.

There are just a few prominent catalysts that can meaningfully encourage the greenback higher at this point. Risk appetite of market participants is one of the main catalysts.

An ideal situation for the greenback would be an aggressive decline in riskier assets such as equities, corporate debt and commodities along with a rally in gold and other safer and liquid assets.

Economic data due for release from the US this week is unlikely to generate meaningful volatility.

Consumer credit will take measure of lending conditions, the NFIB small business optimism will gauge hiring expectations for the largest employer group, the monthly budget will track the fiscal deficit and the University of Michigan sentiment survey will gauge consumer willingness to spend.

None of these are likely to materially alter the US’s relative pace of growth, risk appetite trends or the timing for rate hikes.

Market participants, may also find it important to keep a track on the longer-term developments.

Concerns that will weigh more heavily in the near future are the underperformance of US treasury yields, the burden of a record fiscal deficit and the eventual withdrawal of stimulus.

In the local inter-bank market, participants would keenly follow the advance estimates of the GDP for the current fiscal year.

With 8.5% growth widely expected any significant positive surprise is unlikely, especially with growth prospects in the next fiscal year look weaker on account of high food and energy inflation and rising interest rates.

In fact, last week even PM Manmohan Singh also expressed his reservations on maintaining current growth momentum in the prevailing high inflation environment.

Market participants would also continue to follow the developments in the stock market.

Weakness in the local equities has persisted and that combined with low interest from FIIs could keep rupee under pressure. 
Moreover, with Brent crude oil price hovering around $100 for the first time since October 2008, rupee also remains vulnerable to a global commodity price spiral.

Any weakness in the greenback in the overseas market would however, be supportive for the rupee.

Over this week, the rupee-dollar pair is likely to trade in the range of 45.40 - 46.00.

The writer is senior economist, Royal Bank of
Scotland NV, and can be reached at gaurav.kapur@rbs.com. Views are personal