Hopes of policy action to help the rupee

For much of last week, risk appetite was strong in the financial markets. However, weak economic data and a surge in Spanish bond yields saw investors turn risk-averse on Friday.

In the global currency markets, the euro depreciated against the US dollar for the first time in three weeks as signs of slowing global economic growth added to concern Europe’s sovereign-debt crisis is worsening, damping appetite for riskier assets.

Gains made amid initial investor optimism regarding the European Central Bank’s (ECB) July-end decision to consider buying Spanish and stressed euro zone government bonds, have steadily eroded. Commodity Futures Trading Commission data showed that futures traders continued to reduce their bets that the euro will fall against the US dollar.

The Japanese yen rose against other major global currencies as risk appetite faded, increasing demand for safer asset classes and currencies. The yen made strong gains against the greenback, the euro and the Australian dollar after data revealed that Chinese exports growth collapsed in July.

The Indian rupee and the South Korean won led gains in Asian currencies last week as foreign funds increased holdings of emerging-market assets amid speculation global central banks will ease monetary policy to spur growth. Asian currencies continue to gain ground against the dollar, pricing in a higher probability that the Federal Reserve and the ECB will provide significant monetary easing.

The rupee had its biggest weekly gain in six weeks amid speculation the new finance minister, P Chidambaram, will announce measures to narrow the budget deficit and attract investment. That raised hopes of local and foreign investors alike. Foreign institutional investors (FIIs) remained net buyers of local debt and equities with $563 million of net purchases last week.

Indian market participants were also buoyed by the prospect of monetary easing as industrial production contracted even as the government curbs its subsidies bill and fiscal deficit. Last week, the rupee-dollar pair traded in the range of 54.96-55.66; the rupee gained by 0.8% against the greenback.

This week is likely to be relatively ‘empty’, in terms of global economic event risk. So there is little hope of a change in market price action. There is a sense of unease as tensions from European fiscal crises and a slowdown in global economic growth pose clear risks to the status quo. In the absence of any real market catalysts, however, market participants may continue to hold current positions. The safe-haven US dollar cannot do well in such market conditions.

Key data releases due this week start today with the advanced reading of Q2 GDP from Greece. As the region’s weakest link and the likely tipping point on whether the European Union can survive in its current format or not, this reading will carry deeper implications than just extending the multi-year recession.

The euro zone GDP data will be released along with GDP data from key economies such as Germany and France tomorrow. The euro bloc’s economy is expected to contract for a second straight quarter. This data could turn into a short-term catalyst for the underlying risk appetite trends, if the growth troubles for the largest collective economy reignite fear in the region’s sovereign bond market.

On the whole, it could be another week of listless price action in the currency markets. The greenback will do well in flare-ups in market tensions.

In India, the rupee can gain more ground against the US dollar. Media reports suggest that some macroeconomic measures are possible in the next ten days. A generally weaker tone for the greenback would be helpful.

The rupee-dollar pair has had a strong correlation with the euro-dollar pair in recent months and any weakness in the euro against the greenback would have similar implications for the rupee.

On the data front, the WPI inflation data to be released this week, will be also crucial, as any softness in headline inflation rate can further boost hopes of a rate cut by the RBI. Over the week, the rupee-dollar pair will likely trade in the range of 54.75-55.50.

The writer is senior economist, Royal Bank of Scotland NV. Views expressed here are his own.
E-mail: gaurav.kapur@rbs.com