The currency market saw heightened activity last week. Amidst a packed data and event schedule in the US, the market refocused on the Federal Reserve’s interest rate policy.
Gaurav Kapur
The currency market saw heightened activity last week. Amidst a packed data and event schedule in the US, the market refocused on the Federal Reserve’s interest rate policy. This worked in favour of the US dollar initially, with strong inflation, high capacity utilisation and robust growth in industrial production, supporting the Fed rate hike expectations. However, Fed chairman Ben Bernanke’s dovish testimony to the Senate on the economy and monetary policy weakened these expectations considerably, pulling the greenback down.
The first three days of the week saw key US data releases, including June industrial production and capacity utilisation, June producer and consumer price inflation and the US treasury’s report on cross-border capital flows. Core consumer price inflation hit 2.9%, the highest since 2001, while the core producer price inflation was relatively tame. US treasury data showed that net foreign capital flows into the US rose 36% to $69.6 billion in May from $51.1 billion in April.
In his testimony on Wednesday, Bernanke indicated that the US growth is moderating and inflation pressures should subside consequently. This created uncertainty among market participants on the future course of the Fed monetary policy. On Thursday, the minutes of the June 29 meeting of the Fed rate-setting committee showed some disagreement among members on inflation pressures. That added to the prevailing confusion. After these events, the money market scaled down the probability of an August Fed rate hike to below 50% from 65% earlier.
The greenback, as a result, closed the week a tad lower against the Euro, considerably weaker against the pound sterling and almost unchanged against the Japanese Yen. The pound sterling thus outperformed other major currencies last week.
Robust economic data releases in the UK, especially higher-than-expected GDP growth and perky consumer price inflation, raised the prospects of rate hike by the Bank of England. That helped the pound sterling.
The Yen was undermined by renewed dovishness of the Japanese officials. A bank reserve requirement hike by the Chinese central bank after clearly ruling out another Yuan revaluation put a lid on the Yen, too. The Japanese currency had gained on speculation that China would allow greater appreciation of the Yuan to slow down its economy, which grew at 10.9% in the first half of 2006.
The market was expecting some policy measures to give Yuan greater flexibility in the run-up to the first anniversary of its revaluation on July 21. However, the Chinese authorities indicated that any such measure is unlikely over the next few months and they are comfortable with relatively modest pace of Yuan appreciation.
In Asia, the Indian rupee was the worst performer. The rupee lost about 1% of its value against the greenback as intense downward pressures built up during the week. The rupee-dollar rate dipped below its three-year-old resistance level of 46.50 on the back of a host of factors. The key among them were rising crude oil prices (which hovered above $75 per barrel), falling equities market with foreign institutional investors pulling out their funds (BSE Sensex plummeted by 5.4% last week and the FIIs were net sellers of $182.6 million worth of Indian equity and debt) and a stronger US dollar overseas.
To make matters worse, an arbitrage opportunity existed between the off-shore and onshore rupee-dollar forwards market. The rupee-dollar rate quoted offshore was higher than the local market. This added to the demand for dollars locally.
All these ensured that the demand for dollars outstripped supply by a wide margin and the overall market sentiment remained rupee bearish. The RBI supported the rupee by selling dollars in the market around the rupee-dollar rate levels of 46.80 and 47.00.
All this action occurred over the first three days of the week. In the last two days, the rupee did recover some of the lost ground as the dollar weakened overseas and oil prices eased below $75 per barrel. Overall rupee-dollar rate moved in a band of 46.42 - 47.04.
This week, the data release schedule is relatively light. The key data release will be the second quarter US GDP numbers due on Friday. The market could thus move in a range while looking for direction possibly from the Middle East developments or oil prices. The greenback stands to gain from its safe haven status, if the Middle East crisis prolongs. Otherwise, in the absence of any data, support to the US dollar could weaken.
In the local market, the rupee is likely to remain under downward pressure and trade in a band of 46.50-47.00 against the greenback. The rupee could gain if the RBI hikes the reverse-repo rate in its quarterly monetary policy review on Tuesday. The sentiment in the market will be cautious and an oil price flare-up remains the key risk.
The author is senior economist, ABN AMRO Bank. Views expressed herein are personal.
E-mail: gaurav.kapur@in.abnamro.com
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