Stock market support critical for Re to hold gains

Easing tensions over fiscal problems in Greece, fresh signs that the global recovery was holding up — notably with the US jobs data improving — and a lack of negative news on central bank exit strategies provided a solid backdrop for financial markets last week.

Risk appetite of market participants showed significant improvement. Equity and commodity prices rallied across global markets, while government bond prices relinquished some of the previous week’s gains. In the currency markets, the dollar held to its gains against other major currencies despite better risk appetite. Most of the price action among major currencies was seen in the pound.

Sterling tumbled to a 10-month low against the dollar as concerns over the UK’s record fiscal deficit escalated. In a highly active trading session on Monday, the British unit plummeted against the dollar, dropping through the $1.50 level for the first time since May 2009, as opinion polls pointed to the possibility of a hung Parliament after the UK general election in May.

The pound did recover some poise later in the week, with a stronger-than-expected survey of the UK services sector helping to allay fears over the potential for a double-dip recession in the UK. Over the week, the pound fell 0.7% against the dollar, lost 0.9% against the yen and slid 0.7% against the euro.

Meanwhile, the euro lost ground against the greenback, hitting a fresh nine-month low, despite the announcement by the Greek government of new austerity measures to rein in its fiscal deficit, which enabled it to issue €5 billion of bonds to shore up its finances.

But the euro was undermined after German chancellor Angela Merkel dashed hopes of a bailout for Greece. The currency came under more pressure after ECB president Jean-Claude Trichet said in a press conference following the central bank’s policy meeting that the euro-zone’s recovery remained “fragile”. The euro however, managed to finish the week largely unchanged against the dollar.

But the euro rose 1.6% against the yen as the Japanese government stepped up pressure on the Bank of Japan to loosen its monetary policy.

The yen also lost ground as the government said it was raising its borrowing limit for intervention in the foreign exchange market for the first time in six years, sparking speculation that it was gearing up to step in and stem the recent appreciation in the yen. The yen fell 1.6% against the dollar on the week. In the local inter-bank market, the rupee appreciated over 1% against the dollar to a six-week high.

The global stock market rally, combined with positive market sentiment on the back of the budget announcements, pushed up the local stocks by over 3% during the week.

Strong manufacturing PMI data and improving business activity levels in services for February also supported the market impetus, as it indicated growth momentum remains buoyant. The rally in stocks helped power a rally in the rupee. The unit’s gains were curtailed to some extent as corporate demand for dollars emerged at around 45.50/$. Over the week, the rupee-dollar traded in the range of 45.60-46.09.

That the dollar has remained largely unaffected by the gains in equity markets over the past month seems to suggest that the inverse correlation between market risk appetite and the unit, seen throughout 2009, may be breaking down. This, however, may not mean the greenback has fully relieved itself of this correlation. A strong rally in investor optimism would most likely lead to losses for the unit. More importantly, a rise in risk aversion would still play to the dollar’s safe haven appeal.

In the meantime, it will be important to monitor the larger risks to financial stability. Should the Greek situation deteriorate, or Spain, Portugal or Italy find themselves in a similar position, risk aversion could once again take over.

The scheduled economic event risk from data releases this week does not carry many major market-movers. The retail sales and consumer sentiment data for the US will offer a meaningful overview of health for the economy’s largest sector.

In the local market, the support seen for the rupee last week depends entirely on the stock market movements. On Monday, a stronger-than-expected US non-farm payrolls data is likely to cheer the stock market and thus the rupee. As the week progresses, market participants would continue to look out for events and data influencing the local stock market and the rupee.

Global investor risk appetite will remain a key driving force behind local stocks and the Indian unit. Rising oil and other commodity prices would curtail rupee gains. Overall, the rupee-dollar pair can trade in the range of 45.25-46.00 this week, with an appreciation bias.

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