Weak stock market, rising crude oil price to keep rupee under pressure

In the global financial markets last week, a two-way pull between good news on eurozone sovereign debt concerns and disappointing US jobs data left equity and commodity markets struggling for traction but helped drive the euro’s gain against the US dollar.

A further boost to the single currency came from European Central Bank (ECB) comments on the risks to the region posed by short-term inflationary pressures.

The euro surged higher from a four-month low against the greenback last week as hawkish comments from Jean-Claude Trichet, president of ECB, lifted the single currency.

Trichet struck a tough stance on inflation on Thursday increasing the chances that the ECB would raise interest rates in spite of the eurozone debt crisis. Trichet said there was a risk rising commodity prices could temporarily push eurozone consumer price inflation further above the ECB’s 2% target and the central bank was prepared to take action if rising price pressures became more permanent.

The euro had already received a lift from reports Germany was backing plans to give new powers and lending capacity to the €440 billion eurozone rescue plan. Markets were encouraged from signs that policymakers were considering measures to widen the scope and strengthen the operations of the eurozone bailout fund.

Also lending the single currency support were successful government bond auctions from Italy and Spain, which came a day after a well-received Portuguese sale on Wednesday. Government bond auctions in Spain and Italy were successfully subscribed, heightening the improvement in sentiment fostered by the well-received sale of Portuguese debt. Peripheral sovereign bond yields fell and their spreads over the benchmark German Bunds narrowed. The cost of insuring against possible sovereign defaults, as measured by credit default swap spreads, also fell.

This helped ease some concerns about the fiscal problems of countries on the periphery of the eurozone and followed highly public shows of support from China and Japan, the world’s largest holders of foreign exchange reserves, for the bonds of distressed countries in the region.

The euro, which on Monday hit a four-month low jumped 3.6% to a four-week peak during the week. The euro also hit one-month highs against the yen and the Swiss franc, climbing 3.5% and 3.4% respectively over the week, and 1.6% higher against the pound.

The pound found support elsewhere however, climbing 2% against the US dollar during the week as rising UK inflation raised speculation that the Bank of England would move to tighten monetary policy sooner than expected. Meanwhile, the greenback fell 0.1% against the yen during the week, eased 0.3% to against the Swiss franc, but rose 0.7% against the Australian dollar.

In the local inter-bank market, rupee finished the week flat after gaining in the first half of the week. The Indian unit gained on the back of a pick-up in portfolio inflows and weaker US dollar. However, the rupee lost most of its gains as stock market slide continued and global crude oil prices rose. Over the week, the BSE Sensex fell by over 4% during the week, while international crude oil prices climbed back above $90 per barrel. Over the week, the rupee-dollar pair traded in the range of 45.03-45.53 and the rupee closed the week unchanged against the greenback compared to the previous week.

This week is a relatively easy week in terms of US economic data-related event risks, which leaves volatility expectations considerably lower through the short-term. Little foreseeable event risk leaves the greenback at the whims of broader market flows and developments in ongoing eurozone fiscal crises. Possible exceptions include mid-week US housing starts and existing home sales reports, but it would take a substantial surprise in either direction to force significant moves in the US dollar.

One potential market-mover may come from the Chinese Q4 2010 GDP growth estimates on Wednesday night/Thursday morning. The Chinese economy has defied a broader global economic slowdown and continued to grow at impressive double-digit rates, but market participants will need to see similarly robust expansion into the final quarter of 2010. Any significant disappointments in the Chinese growth data could especially affect the Australian and

New Zealand dollars — forcing them lower against the greenback.
The month of January is often critical in determining currency market trends for the rest of the year. The determining factor may come down to whether the equity markets and broader risk sentiment can continue to improve. Investor risk sentiment may see a substantial correction following robust gains. It will be critical to watch the trajectory of ‘risk’ sentiment and its effects on the US dollar through the second half fortnight of January.

In the local market, participants would keep a close watch on the stock market movements. Equity market has been falling in the new year. Third quarter corporate earnings results would determine whether market sentiment improves. Growing downside risks in the form of rising inflation and high interest rates have dampened the investor sentiment and clouded the expectations of corporate profitability in the coming fiscal year. In that context, corporate results will be in focus and any weakness in the results could prolong the stock market slide. Any downside pressures on the stock market would keep the rupee under pressure.

Rising global crude oil prices also pose another risk to the rupee’s strength. Developments in the eurozone sovereign debt issue would also be closely monitored and any signs of debt troubles growing would negatively affect investor risk appetite and riskier assets like equities. Over the week, the rupee-dollar pair would continue to trade in the range of 45.25-45.75 with a weakening bias for the rupee.

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