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Key US data releases due this week would be the main focus

Currency market price action was driven by some improvement in risk appetite last week.

As the likelihood of a 0.50% rate cut instead of a 0.25% cut by the Federal Reserve on December 11 increased, equity markets rallied across the globe.

Stocks also surged on news that Abu Dhabi was set to take a stake in Citigroup, the largest US bank, soothing some concerns over the health of the financial sector.

This backdrop saw the yen take some beating against high-yielding currencies, as investors got back into carry trades.

The US dollar turned out to be the out-performer among the major currencies, but it too lost value against high-yielders like the Australian and the New Zealand dollars.

Speeches from Ben Bernanke, chairman of the Fed, and Donald Kohn, the Fed’s vice-chairman, signalled that the Fed was leaning towards more interest rate cuts.

Futures markets, which were already pricing in a 0.25% cut in the overnight Fed rate, moved to price in a 30% chance of a 0.50% move instead.

The resulting rise in risk appetite boosted demand for carry trades, in which low-yielding currencies are sold to fund the purchase of riskier, higher-yielding assets.

The yen fell 2.7% against the greenback, 1.2% against the euro and 2.5% against the pound. It tumbled 3.2% against the Australian dollar and 3.6% against the New Zealand dollar.

Higher-yielding currencies also advanced against the greenback too, with the Australian dollar gaining 0.4% and the New Zealand dollar climbing 0.9%.

The US dollar fared better against its major peers, pulling away from November 23’s record low of $1.4968 against the euro.

This was in spite of the reduction in yield support implied by increased expectations for further cuts in interest rates and an above-forecast reading of euro-zone consumer price inflation.

The greenback has been in the oversold zone for last few weeks now and unwinding of these positions could be behind its strength last week.

The UAE dirham rose to a 17-year high against the greenback, as speculation persisted that the country might move away from the Dirham’s peg to the struggling US dollar ahead of this week’s summit of Gulf Arab states.

The currency, which has been fixed at Dh3.6725 against the dollar since 1997, hit a high of Dh3.6564 on Friday, while the forward market moved to predict a 3.6% appreciation in the dirham in a year’s time.

In the local inter-bank market, the rupee came under some pressure last week. Over the first three days, it lost about 0.3% of its value against the greenback, on strong demand for dollars.

Oil companies were in the market to buy dollars. The FIIs also remained net sellers of local assets, to the tune of $398.1 million during the week.

Exporters took the opportunity to sell dollars, as the rupee touched a one-month low against the US dollar.

Over the next two days, however, the rupee recovered its losses to finish the week marginally stronger, as the sentiment towards the rupee improved.

A rebound in the stock market and strong GDP growth data for the second quarter along with a sharp drop in oil prices, comforted market participants that capital inflows would pick-up going forward and the trade deficit would be reined in too.

The rupee-dollar pair traded in the range of 39.57-39.90 during the week and the Indian unit appreciated by 0.2%.

This week, the focus of the market participants will be on the slew of keyUS data releases, like ISM manufacturing and all important employment conditions indicator, non-farm payrolls, for the month of November.

Consensus expects the economy to have added only 77,000 jobs compared to the 166,000 last month. Given the degree of weakness expected in the rate of job-creation, only a very big positive surprise would help the beleaguered greenback.

Otherwise, the US dollar would tend to weakenin the last month of year, as it has a great seasonal tendency to fall in December.

However, in the run-up to crucial data releases this week, market participants are unlikely to aggressively add to already heavy short-dollar positions.

The strength of the US data releases will also decide the odds of a 0.50% Fed rate cut. Weakness in these crucial numbers would mean the market will raise the chances of a bigger cut in rates in December and that would further boost risk appetites and the equity markets.

In the local market, if oil prices slide further below $90 a barrel, it will be beneficial for the rupee. The OPEC will decide on whether to raise output or not this week.

However, the fact that the pace of capital inflows remains tepid and FIIs remain net sellers will remain a cause for concern.

A lot also depends on the equity market conditions, which should be broadly rupee supportive this week too. The rupee-dollar pair could therefore trade in a range of 39.40-39.80 this week, with a mild bias for the rupee to strengthen.

The RBI is likely to remain active in curbing rupee appreciation.

The author is senior economist, ABN Amro Bank. Views expressed herein are personal. E-mail: gaurav.kapur@in.abnamro.com