Rupee may fall against euro, yen, but continue to rise against the dollar | Business Standard Column–08.01.2018—–*****

The global currency market has been braced for volatility, as the Brexit negotiations drag on. December saw a string of central bank policy reviews but none of the big decisions surprised. However, the new year has brought surprises, in terms of unexpected trends.

The consensus opinion was that the pound would be under pressure. The Bank of England held its policy rates but the UK is suffering the twinned curse of higher inflation and recession. However, it’s the US dollar which has taken a hammering in the last 10 days, dropping to six-month lows versus most currencies. The Dollar Index, which measures the dollar versus a basket of six other currencies, is down below 92. The rupee is at a 30-month high versus the dollar, edging to the Rs 63.5-mark.

On the face of it, this is odd. The Federal Reserve hiked the policy rate in December. Bond yields have risen. The Fed has also signalled that it might hike rates thrice in 2018. Meanwhile, US inflation remains low, which means the real return on US debt has risen.

Since the euro is running a negative policy rate and so is the yen, the primary expectation would be that the dollar should harden. Instead, the whole of 2017 has seen the dollar sliding; now down 14 per cent against the euro in the past 12 months.

One possible reason is that the Euro zone has seen strong growth for the first time since the global financial crisis. There are expectations that the European Central Bank will cut its ongoing Quantitative Easing (QE) programme entirely after September. The QE has already been halved in terms of quantum. There are also expectations that the ECB will raise policy rate in 2018. Hence, forex traders are front running Mario Draghi taking positions that would gain if the consensus is right.

Traders are seeing a technical danger signal in the US yield curves. The curve compares yields for different tenures of government debt, is considered healthy, if longer tenures have higher yields. If the curve flattens with little yield differential, or if it inverts with short tenure yields higher than long-tenure yields, it implies investors are expecting recessive conditions.

The US yield curve is flattening. This seems odd; in that the US economy seems to be doing fine and the stock market is roaring to new highs. However, there is just a chance that the Fed will hike rates even more enthusiastically if it thinks the Trump tax cuts will lead to higher inflation.

There are several implications for India. One is that this could spark off a rally in gold. Dollar weakness often leads to a rally in gold prices it is started artificially since world gold prices are dollar-denominated.  But, if the dollar-gold ratio is down, there tend to be speculators getting into the metal, which creates some momentum. Given the desi love affair with gold, this will be greeted joyously. Other commodities can also be pushed into rallies for similar reasons.

It’s important to note that the rupee retains stable exchange rates with the euro and yen but much of India’s foreign trade is dollar-denominated. Apart from North America, trade with Latin America, East Europe, and Africa is dollar-denominated.

A stronger rupee will, therefore, lead to somewhat slower exports. But, it still might help with the trade balance, since imports will get cheaper. A stronger rupee should also help curtail domestic inflation, since crude oil import prices have a serious impact and crude oil is dollar-denominated.

As far as the forex trader is concerned, the dollar-rupee equation has moved in the ‘wrong’ direction. Now, it’s a question of riding this trend and waiting for the dollar to bottom out. The euro-rupee trend remains somewhat in favour of the euro and traders are betting that the euro will strengthen even more.

What holds for the euro holds for the yen as well. Japan has seen its best year in terms of growth in two decades. The Bank of Japan also has a negative interest rate and a massive QE running. There have been hints of tightening. That could drive the yen up. There may be a potential set of trades here with the rupee dropping versus the euro and yen, even as it rises versus the dollar.

via Rupee may fall against euro, yen, but continue to rise against the dollar | Business Standard Column

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