Emerging currencies slip on risk aversion

Risk aversion returned as the theme behind currency market action last week. High-risk currencies, typically emerging market currencies, backed by high local interest rates, were sold in favour of the low-yielding currencies, Japanese Yen and the Swiss Franc and safe haven currencies like the Euro.

The back drop for such a move was heightened political and economic risk, along with the fears of a slowing US economy. 

As a result, versus the US dollar during the week, the Turkish Lira fell 3.8%, the South African Rand 3.4%, the Brazilian Real 1.9% and the Mexican Peso weakened by 1.2%.

The Thai Baht recovered from a military coup in the country, to close only 0.3% weaker to the greenback.

Investors and speculators had cut their positions in riskier assets like the emerging market currencies, commodities and equities in a similar fashion, between late-May and early-June this year.

Post that shake-out, high risk currencies enjoyed a strong rebound. Low interest rates encouraged speculators to re-enter carry trades and build up large speculative positions, going short on the Yen and Swiss Franc.

The price action among the major currency pairs was confined within the recent ranges. The US dollar registered a broad-based decline against its other major counterparts last week, but its slide was not very sharp. The Swiss Franc outperformed the other three major currencies in terms of its gains against the greenback.

After ignoring a raft of weak data earlier last week, the US dollar finally gave ground on the back of a disappointing Philadelphia Fed index on Thursday.

The Philadelphia Fed index, a composite indicator of economic activity in the region, fell short of consensus estimates of 14.3, instead posting a dramatic decline to -0.4 in
September. This is the first time the index turned negative in three years.

The market barely reacted to weak US housing market, capital inflows and the current account deficit data. The July net capital inflows into the US dipped to $33 billion, their lowest level since May 2005. The US current account deficit, which is financed from these capital inflows, widened to $218.4 billion in the quarter ended June 2006 from previous quarter’s $213.2 billion.

This greenback negative data was, however, countered by the benign comments from the G7 and IMFWorld Bank meetings, which failed to deliver a bounce in the Japanese Yen and the Chinese Yuan.

The decision of the US Federal Reserve’s rate setting committee to keep the overnight Fed funds rate unchanged at 5.25% was in line with expectations.

A hawkish-than-expected post meeting statement, which left the possibility of rate hikes alive, did not affect the ongoing market action much. A sharp decline in the US
treasury yields, which followed the Fed decision and the subsequent erosion in greenback’s yield advantage, turned out to be a key driver of the greenback’s weakness though. In the local inter-bank market last week, the rupee gained value against the greenback, making it the fourth straight week of appreciation. And, the Indian unit slid below the Rs. 46.00 per US dollar mark after three months.

After closing a tad weaker on Monday, the rupee appreciated over the next three days. Exporters, particularly the IT companies and foreign institutional investors sold large amounts of dollars.

The FIIs bought Indian equities and debt worth $390.6 million during the week. Banks too joined in, taking advantage of the arbitrage opportunity offered by the difference in rupee-dollar rate in the offshore-onshore forwards market.

One US dollar was fetching more rupees in the local market compared to the offshore market. Weaker greenback overseas and further oil price decline also underpinned the
rupee.

On Friday, the rupee lost a bit of value, as dollar demand from importers emerged. Overall the rupee-dollar rate moved in a range of 45.815 - 46.17 and the rupee closed the week stronger by 0.5% against the greenback.

This week, the economic calendar in the US has some crucial data releases. Existing and new home sales are due for release - both of which are expected to reflect weakness in the housing market.

The consumer confidence report on Tuesday and the consumer spending report on Friday are also crucial.

Consumer spending is providing crucial support to the US economy and consumer confidence will give a better indication on whether that support is continuing. Market consensus is for a rise in confidence. Thus the outlook for the housing data suggests that we could see more greenback weakness. But a rise in consumer confidence could negate that. The greenback, thus, could hold its ground this week.

Locally, buoyant dollar inflows and upbeat market sentiment favour a stronger rupee. But overvalued equity markets and the possibility of an FII pull-out in the backdrop of risk aversion, remains a key downside risk. The rupee-dollar rate is likely to move in the 45.70 - 46.20 band.

The author is Senior Economist, ABN AMRO Bank. Views expressed herein are personal. E-mail: gaurav.kapur@in.abnamro.com