After a multi-month rally from the March lows, riskier asset classes showed signs of fatigue as risk appetite waned last week. Add to that the possibility that the US dollar — the key driver of bullish market movements - may hit a bottom from which to bounce, and the talk about the start of the long-awaited “correction” intensified.
The US dollar stabilised last week as the rally in risky assets appeared to falter and the US Federal Reserve made rare comments on the value of the currency. The greenback started the week on the back foot, hitting a 15-month low on a trade-weighted basis on Monday, after stronger-than-expected Japanese growth data boosted risk appetite and weighed on safe haven demand for the greenback.
Japanese data boosted risky assets such as equities and heightened demand for carry trades, in which low-yielding currencies such as the US dollar are used to fund the purchase of riskier, higher yielding assets. The dollar index, which tracks its value against a basket of six leading currencies in trade-weighted terms, dropped to a low of 74.679 on Monday.
However, the greenback recovered later in the week as the rally in global asset prices looked to run out of steam. With the year drawing to a close, investors booked profits after the strong run in asset prices since March. Comments from Ben Bernanke, chairman of the US Federal Reserve, who said the central bank was monitoring currency markets “closely” and would conduct policy in a way that would “help ensure that the dollar is strong”, also helped in the recovery of the greenback.
Market participants considered these comments as significant, because remarks on the US dollar are usually the remit of the US Treasury. But many doubted that the Fed was preparing the way to intervene to support the greenback, given its monetary policy stance of keeping the Fed rate near zero for an extended period of time, in order to support economic recovery in the US. The key reason behind dollar weakness is the ultra-loose monetary policy setting and the Fed’s position at the back of the queue for rate hikes.
There is little prospect of this scenario changing in the near-term. The dollar index pulled back to stand up 0.8% to 75.674 over the week. The greenback rose 0.4% against the euro and gained 1.1% against the pound over the week.
Risk appetite was also unsettled by news on Wednesday that Brazil would further tighten restrictions on short-term speculative inflows that had been boosting its currency. This sparked market speculation that other emerging countries, especially in Asia, would follow suit and impose capital controls in a bid to stop their currencies’ from appreciating and damaging their export sectors. Over the week, the Brazilian real rose 0.9% against the US dollar.
Commodity-linked currencies were also hit as risk aversion heightened. Against the US dollar over the week, the Australian dollar fell 1.9%, the New Zealand dollar 2.1% and the Canadian dollar 1.2%. The US dollar did fall 0.9% against the Japanese yen on the week, as falling investor confidence gave the yen a lift.
In the local inter-bank market, rupee lost some ground against the greenback. Volatility in the equity market and dollar’s strength overseas led to some depreciation in the Indian unit during the week. This was despite continuing FII inflows and overall stock market gains during the week.The rupee-dollar pair traded in the range of 46-46.75 and rupee depreciated by 0.6% against the greenback.
This week, a slew of data is due for release in the US, which heightens the event risk.
The first release is the unpredictable existing home sales report, which often goes unnoticed but occasionally produces great market volatility. The following day brings the second release for Q3 US GDP figures, Conference Board Consumer Confidence survey results, and the minutes from the Federal Open Market Committee’s most recent policy-setting meeting. All three events have been known to force considerable moves in the S&P 500 and dollar, and it remains important to watch for surprises from each.
Fed chairman Ben Bernanke recently took currency markets by surprise when he said that the Fed was paying close attention to exchange rate movements. Markets will therefore pay very close attention to any references to the dollar in the Fed’s discussions. There are low odds on any explicit mention of the greenback in the Fed minutes, but such low expectations could make for extensive volatility if we do see the Fed talking the dollar higher.
Personal income and spending, durable goods orders, and new home sales reports round out the week of significant greenback event risk. Any of these releases could likewise spark big moves — especially in the relatively illiquid trading session before the US holiday. Broadly, the dollar remains range bound against major counterparts, and exceedingly low volatility expectations suggest that it may remain restricted through the week ahead.
In the local market, the rupee could remain under some pressure if market participants continue to reduce their risk appetite as the year-end approaches. Moreover the stock market is clearly finding it difficult to establish new highs and has been stuck in a range for a while now. Reflecting that, even the rupee has been range bound. And, with US dollar seemingly close to a bottom at least for this year, there is little momentum for any sharp appreciation like we saw in October. Overall, there is some bias for rupee to remain weak, but it will trade within its current range of 46-46.75.
The writer is senior economist, ABN Amro Bank. Viewsare personal.
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