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ShareThe market focus last week turned towards central bank policy actions ahead of the Federal Reserve's monetary policy meeting and the European Central Bank (ECB) funds auction.
The Fed dampened expectations of an early hike in US interest rates and the ECB pumped €442 billion of one-year funds into the Euro-zone banking system.
Later on Thursday, led by the US Fed, major central banks announced an extension of their currency swap lines until February 2010, ensuring there was adequate dollar funding. These central bank actions and policy decisions helped stoke risk appetite among market participants.
At the start of the week, risk aversion grew after the World Bank said it expected the global economy to shrink more this year than it had previously expected. Countering that to some degree was a comment by the OECD that the global outlook appeared to be improving for the first time in two years.
Risk appetite improved on Thursday following the actions of the central banks. Emerging market assets benefited the most from this improved risk appetite.
In the currency market, the US dollar lost ground last week. The greenback came under pressure after Wednesday's Federal Open Market Committee meeting at which the Fed made it clear that any exit from its ultra-loose monetary policy will take some time. That encouraged market participants to abandon the US dollar in search of riskier, higher-yielding assets.
Confidence that US monetary policy will not undergo changes anytime soon allowed participants to use the greenback as a funding currency, as risk appetite driven trading persisted.
The big liquidity injection from the ECB also lifted sentiment on Wednesday.
The US dollar came under more pressure on Friday, as China reignited concerns that it might diversify some of its foreign exchange reserves away from the US currency.
In its annual financial stability report, the People's Bank of China made a fresh call for a "super-sovereign" reserve currency and for the International Monetary Fund to help in reserve management. Over the week, the US dollar fell 0.8% against the euro and lost 1.1% against the yen.
The dollar also suffered against emerging market currencies as improving risk appetite prompted investors to search out yield. The US dollar lost 2.7% against the South African rand over the week, fell 2.1% against the Brazilian real and dropped 1.2% against the Turkish lira.
The other major global currency, the pound, suffered as comments from Bank of England officials tempered demand for the currency. Mervyn King, the governor of the bank, described Britain's road to recovery as a "long, hard slog". Spencer Dale, the bank's chief economist, said the central bank's policy of buying government securities could weaken the pound when it purchased bonds from foreign investors. Over the week, the pound fell 0.7% against the euro and fell 1% against the yen.
The Swiss franc fell amid speculation that the Swiss National Bank (SNB) had intervened to stop the currency appreciating through SFr1.50 against the euro. The SNB was believed to have sold the Swiss franc aggressively, in an attempt to defend the level as it continued its attempts to stop currency appreciation. The Swiss franc dropped 1.1% against the euro on the week and fell 0.3% against the US dollar.
In the local inter-bank market, the rupee came under pressure during most of the week, but recovered all the lost ground on Friday. The Indian unit remained weak against the US dollar over the first four days of the week as FIIs pulled their funds out of local assets and month-end demand for dollars by importers emerged.
The rupee got some support from dollar selling by market participants as the rupee-dollar pair hit the crucial technical level of 48.90 on Tuesday. A sharp rally in the equity market on Friday helped the rupee push higher and recover its losses. The rupee-dollar pair traded in the range of 48.08 - 48.94 and the rupee finished the week flat against the US dollar.
This week, risk appetite remains in a fragile state. If risk sentiment takes a sharp turn for the worse, we could see the US dollar rally against major counterparts. A busy US economic calendar could prove to be the catalyst for a sustained turn in the major currency pairs.
Markets will watch for Wednesday's ISM US manufacturing sector report. The ISM report will shed light on conditions in the manufacturing sector, and it will be important to watch for continued signs of improvement in domestic demand.
The survey's new orders and output indices plummeted to record-lows through the end of 2008, but steady improvements saw the new orders index in positive territory for the first time since October 2007 in the May survey. Market will watch for continued improvement to cement the case for a sustained turnaround in production.
The other crucial data release is the Bureau of Labor Statistics' estimates of employment in the US economy in the non-farm payrolls report on Thursday. The US economy has shed 7 million jobs since December 2007 and forecasts call for a further 350,000 job losses during June.
A much smaller-than-expected decline in May boosted market outlook for the US economy. To improve the odds of economic recovery, non-farm payroll data will need to show much more dramatic improvements. Any signs of deterioration could easily belie hopes that the worst of the recession is now past.
In the local market, the Markit Manufacturing PMI report for June to be released on Wednesday would be crucial. The PMI data for last two months has shown that the manufacturing sector is expanding and going by the strong new orders reading in the month of May, the June headline PMI number is likely to continue signaling expansion in business activity.
That would boost the equity market and the rupee. Otherwise market participants would follow the key US data releases this week. Any deterioration in the risk appetite would end up pushing the rupee lower against the greenback. The bias this week could be for a weaker rupee. Overall the rupee-dollar pair could trade in the range of 47.75 - 48.50.
The author is senior economist, ABN Amro Bank. Views expressed herein arepersonal.
E-mail: gaurav.kapur@in.abnamro.com
