Rupee likely to consolidate as downward pressures are gaining traction

Financial markets continue to price in the possibility of another round of support from the US Federal Reserve for the US economy.  Economic data from the US, especially the employment data remained to supportive of the case for a further round of quantitative easing by the Fed.  The US dollar continued its decline as result. Currency markets saw intense greenback selling.

The US dollar has found little support since the US central bank’s monetary policy meeting in September when the chairman of the Fed, Ben Bernanke, said in a statement after the meeting that the Fed would act “appropriately” should economic conditions worsen. Market participants have taken this to mean that another round of quantitative easing is on the way, probably at the Fed’s November meeting.

A survey by Citigroup published last week showed that 90% of investors expected the Fed to announce a second asset purchase scheme on November 3. It showed that, on average, investors expected the US central bank to increase its balance sheet size by $535 billion.

Last week, Japanese central bank announced that it would embark on a fresh asset purchase scheme, earmarking Yen 5,000 billion ($60 billion) as part of this “comprehensive monetary easing policy”. The Bank of Japan (BoJ) also lowered its policy interest rate from 0.1% to a range of 0% - 0.1%. There were suggestions that BoJ announced the scheme as part of its strategy to weaken the Yen. Losses in the Yen were however, short lived.

Dollar weakness against the Yen was the most closely watched price action of the week. 

Japanese authorities did not intervene to arrest their currency’s relentless appreciation, even after it surpassed the level at which they last entered the market. When the BoJ intervened on September 15, the US dollar had just reached a 15-year low.

The greenback stood 1.6% lower over the week, and well below the Y82 level that many market participants had thought represented the “line in the sand” for the BoJ.

There was however, little chance of any move from Japanese central bank, as most of the G7’s key finance officials were gathered in Washington for a weekend summit that included a meeting at the IMF. 

The US dollar, now very close to its all-time low of Y79.70 against the Yen, was weaker across the board. It lost 1.1% over the week against the Euro to and was down 0.9% against the Pound.

Weaker-than-expected employment data in the US added to the gloom on Friday. The data contrasted with stronger-than-expected Australian employment numbers that helped lift the Aussie dollar 1.4% and sparked speculation that parity between the two dollars would be reached in coming sessions.

In the local market rupee remained on a stronger ground against the US dollar, but the extent of appreciation was muted compared to its performance in recent few weeks.

The Indian unit rose to a 25-month high against the greenback over the first four days on the back on continuous inflow of FII funds into local stocks and debt and the general weakness in the US dollar. FIIs were net buyers to the tune of $2.7 billion over the week. On Friday, however, rupee slipped a tad as stock markets corrected.  Over the week, the rupee-dollar pair traded in the range of 44.11 - 44.785.

The US dollar fell sharply against all major counterparts last week, but the fact that it stayed above fresh lows suggests that greenback could correct higher in the week ahead. After a week of non-farm payrolls data, however, US data and event related risk will be comparatively low.

Noteworthy exceptions include the minutes of the previous Federal Open Market Committee policy-setting meeting due on Tuesday. Later in the week the consumer price inflation data could likewise move markets on any surprises. CPI inflation data could prove especially market-moving in light of financial markets’ recent focus on the future of the Fed monetary policy.

Market participants widely expect that the US Fed will make a renewed push towards boosting money supply by enacting fresh quantitative easing (QE) measures in a bid to boost growth. The part 2 of QE is largely priced in to both the US dollar and equity markets now.

Any significantly above-consensus CPI inflation results could subsequently alter market expectations and could very well force a substantive US dollar rally and equity
decline. 

Currency markets stand at a potential crossroads. Clear market focus on greenback weakness suggests that we may be nearing a bottom for the US dollar.

Market participants will also be looking forward to the weekend’s meeting of Group of Seven finance ministers. The meeting holds a greater than usual chance of delivering a catalyst to the markets given recent rhetoric about currency wars.

Last week, IMF managing director Dominique Strauss-Kahn warned that governments are risking a currency war if they try to use exchange rates to solve domestic problems. Central banks and governments are actively intervening in the foreign exchange markets and 24 countries including Japan have moved to protect their currencies in recent months.

The RBI has remained on the sidelines since December last year and has not even intervened in the market in recent weeks, despite the sharp appreciation of the rupee.

There was however, some verbal intervention as the deputy governor mentioned that large and disruptive capital inflows would prompt RBI action.

The rupee may continue consolidate against the US dollar over this week, however the pace of appreciation is likely to be muted. Downward pressures from rising commodity prices, especially crude oil which rose by over 1% last week, will keep a check on the appreciation of the Indian unit.  Any slowdown in the pace of FII inflows could also arrest rupee’s appreciation.

Market participants will follow the August industrial production data and the September WPI inflation data due this week, to get cues on the course of the RBI monetary policy.

Any uptick in inflation combined with a strong headline industrial production number could increase the chances of the RBI raising rates and prompt a correction in the equity market and the rupee. Over the week the rupee-dollar pair can trade in the range of 44.10 - 44.80.

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