Dollar may hold key to stock price movement

Wondering whether the stock market will move higher in the days to come? You can turn your attention towards the US dollar to arrive at an answer. The dollar’s movement appears to wield a big influence on Indian stocks.

An analysis of the long-term movement of the Nifty 50 and the dollar index (which captures the movement of the dollar against the euro, pound, yen, Canadian dollar, Swedish Krona and Swiss franc) shows that Indian stocks are highly sensitive to dollar movement.

The Nifty and the dollar have an inverse relationship — that is, a fall in one would make the other rally and vice versa. The period since 2003 was divided into 19 phases based on the movement of the Nifty. In 15 of those phases, a rise in the Nifty was accompanied by a fall in the dollar index and a decline in the Nifty was coincided with a stronger dollar index.

Out of the 19 moves, the rupee and the Nifty moved in the same direction only six times. The strong link between the Nifty and the dollar index can be explained by the Indian market’s positioning as a risky asset and the latter’s status of a safe haven.

Global flows have largely dictated Indian market moves in recent times and they tend to move into safe havens when risk aversion is high and into risky assets when the appetite for risk is bigger.

The link

In the sharp fall witnessed in 2008, the US sub-prime mortgage crisis caused a wave of risk aversion in markets.

The Nifty fell 60 per cent between January and October 2008, but the dollar index surged 14 per cent in this period. In 2015, too, as equities were sold on fear of the US beginning its interest rate hikes, the Nifty 50 fell about 23 per cent between March 2015 and February 2016, but the dollar index rose 2 per cent. Similarly, a sharp fall in the dollar index has mostly been accompanied by a rally in the Nifty 50. The aftermath of the 2008 US crisis is a classic example. Between March and June 2009, the Nifty 50 recorded a strong 81 per cent rally while the dollar index tumbled 10 per cent.

Likewise, the 31 per cent rally in the Nifty 50 between May and November 2010 was accompanied by a 12 per cent fall in the dollar index.

The exceptions

However, when the Nifty 50 movement is led by exceptionally strong domestic events, the link weakens considerably. For instance, between August 2013 and March 2015, both the Nifty 50 and the dollar index witnessed a robust rally.

Two major events in this period, namely, Raghuram Rajan taking over as Reserve Bank of India Governor and Narendra Modi becoming the Prime Minister, drove the stock market rally. The Nifty 50 gained 70 per cent in this period. This was despite the 17 per cent rally in the dollar index in this period.

What next?

In short, if the rally in the Nifty has to continue, the dollar index should not strengthen too much from here. The dollar index has been struggling to sustain above 100 ever since it broke above this psychological level in November 2016.

The index has come under renewed pressure after the recent US Federal Reserve meeting. It is evident from the muted reaction of the dollar to the recent rate hike that unless the Fed turns aggressive and increases rates faster than expected, a strong rally in the dollar is unlikely.

The markets appear to have largely factored in three rate hikes in the US in 2017. With just two more rate hikes on the cards for the rest of the year, the Nifty appears relatively safe, for now.

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