Geopolitical developments on the Korean peninsula need to be closely followed as it could prove to be a trigger for a sudden spike in USD/INR
The rupee on Monday suffered another blow to plunge to a six-month low of 65.10 against the US dollar after heavy buying of the US currency and concerns on the macroeconomic front. This was the weakest closing for the home currency since March 24, when it had ended at 65.41 against the greenback. Besides panic dollar buying by corporates and importers, fears over fund outflows from domestic capital market led to weakened forex market sentiment against the backdrop of imminent Fed rate hike and unwinding of its stimulus measures amid unsupportive global factors. This author explains why the rupee could fall to 66 levels in the near term as said by Ripples Advisory Private Limited, Indore.
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After a protracted phase of low volatility, USD/INR broke through the key resistance at 64.35 last week due to a combination of global and domestic factors. Rupee saw the biggest weekly decline in 11 months and it was one of the worst performing Emerging Market (EM) currencies in this period. The move was not entirely unexpected as the short positioning in USD/INR was overstretched both onshore as well as offshore and an unwinding of carrying trade was on the cards. You can also subscribe the daily news and intraday tips from here.
On the global front, the US Federal Reserve dot plot indicated that twelve out of sixteen members are expecting a 25bps rate hike by the end of 2017. The probability of a December hike has risen to 63% from 38% a week ago. The US Federal Reserve also announced that the process of reduction of its balance sheet would get underway in October. This has pushed the US yields higher and has caused the US Dollar to strengthen especially against the EM currencies. One needs to closely track the US yields and difference between the 10y and 2y US yields. As the yields head higher and the 10s-2s spread widens (indicating a rise in inflation expectations and steepening of the yield curve), it could push the US Dollar higher especially against Asian and EM currencies. The tax plan to be unveiled by the Trump administration on 25th September could also be a trigger for US yields. The tax plan could likely outline tax cuts that both Democrats and Republicans agree on and this enhances the likelihood of it passing through the Congress. The US government has averted a shutdown by postponing the Debt ceiling to December but the concerns could re-emerge towards the end of this year.
On the Domestic front, macroeconomic factors seem to be tilting against the Rupee. Widening trade deficit owing to sharper pickup in imports (on account demonetization and GST supply shock) than exports and concerns over the government meeting its fiscal deficit target for the year could weigh on the Rupee. There is uncertainty around center’s indirect tax collections due to transition to GST and if additional fiscal measures are introduced to support growth, it could weigh adversely on domestic yields which in turn could spook FPIs that have invested heavily in Indian government bonds this year. A large part of the move in the Rupee in the last week could be attributed to offshore unwinding. The 1M onshore-offshore spread which was around 4-6p until last week was -4p this week indicating tremendous unwinding of offshore carry positions. It will be interesting to see what is the stance of the central bank when there is pressure on the Rupee to depreciate. When Rupee was appreciating, the central bank intervened and sought to keep Rupee in line with other Asian currencies. By doing so it has bolstered its reserves (USD 403Bn now).
The central bank, therefore, has the cushion of reserves to prevent Rupee from depreciating this time around unlike in 2013. It also has the option of intervening in the exchange-traded currency futures market. The central bank will have to strike a delicate balance between ensuring the export competitiveness of rupee (due to Rupee strength) and inflationary pressure (due to Rupee weakness).
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