Currency Call. Brace for a bumpy road ahead

The Indian financial market could have a turbulent opening today after a long weekend. While the market was celebrating Holi, the festival of colours on Friday, there was a bloodbath in the global markets with sell-offs in emerging markets, vulnerable currencies and all manner of assets deemed risky.

Data showing US non-farm payrolls rising by 295,000 in February as against the market expectation for a rise of 240,000 was the trigger for these upheavals. So was the US unemployment rate falling to 5.5 per cent in February from 5.7 per cent the month earlier.

Financial markets had been resting easy on the US Fed putting off its rate hikes until now. But this data has resurrected speculation in the market that the Federal Reserve could reconsider and put through rate hikes earlier.

The data turned market players risk-averse. The dollar, a beneficiary of both US rate hikes and safe haven demand, surged. The Indian rupee could feel the heat and could open with a gap-down today.

The currency closed on a weaker note last week after failing to take cues from some positive developments. The rupee opened at 61.89 on Monday. The surprise 25 bps rate cut from the Reserve Bank of India saw it strengthen to 61.66 on Tuesday. While a rate cut is positive for foreign portfolio flows into equity markets (lower rates lift earnings), it is a negative for similar flows into debt markets.

The currency failed to sustain higher and fell sharply breaking below the psychological 62 mark. The rupee fell to a low of 62.33 on Wednesday and recovered from the low to close at 62.17, down 0.53 per cent for the week.

Domestic macro economic data releases were not in favour of the rupee. The HSBC’s Manufacturing Purchasing Managers’ Index (PMI) fell to a five-month low of 51.2 in February from 52.9 in January. The fiscal deficit has surpassed the Government’s full year target in just ten months.

The deficit as of January stood at ₹568,000 crore, which is 107 per cent of the target of ₹531,000 crore. This week, the Index of Industrial Production (IIP) and the RBI’s much-watched Consumer Price Index (CPI) inflation data are due for release on Thursday.

The dollar index (at 97.72) surged 2.5 per cent last week. A major part of this surge happened after the strong jobs data release on Friday. For anyone who tracks the US Federal Reserve closely, the sell-off in risky assets after this release and revived speculation for an early rate hike seem to be an over-reaction.

Bets on rate hikes can change again based on further data points. Although US unemployment has declined, for instance, average hourly earnings still remain stagnant.

Earnings have actually dropped 2 per cent (year-on-year) in February after rising to 2.2 per cent in January.

It is evident from the earlier meetings that the US Federal Reserve is already convinced about employment trends. Its concern is really about the housing sector recovery being overstated. So, the panic button on US rates needs to be pressed only after the growth in the housing sector actually shows a strong pick-up.

A significant improvement in hourly earnings may also act as a trigger.

All the major currencies — euro, yen and pound — are under threat of extending their recent falls. The euro (1.085) has broken its support at 1.10.

As mentioned in this column last week, it is in danger of falling towards parity with the US dollar. The British pound (1.5020) has support near 1.4950. A break below this can drag it to 1.4800 or even to 1.45. The Japanese yen (120.85) can fall to 122.5 against the dollar from current levels.

The fall in the major currencies could propel the US dollar index higher. The next visible resistance for the index is at 101.52 — the 61.8 per cent Fibonacci retracement level.

The rupee has held up relatively well so far (it was the among the best YTD performers among global currencies). But having said this, unmitigated strength in the US dollar could put the Indian rupee under pressure too.

The close below 62 last week combined with recent dollar strength could keep the Indian rupee under pressure this week. The immediate outlook is bearish as long as it trades below the psychological resistance at 62.

A fall to 62.45 looks likely this week. A break below this level can see the rupee weakening to 62.6 or even 62.85 in the short-term.

The Rupee will get a breather only if it breaches 62. In such a scenario, the rupee can strengthen to 61.8 and 61.6 once again. But the possibility is very less for the rupee to gain strength immediately.

The medium-term bearish outlook remains intact for the rupee. Its key resistance is at 61 and a fall to 63.6 and even 64 looks likely in the medium term.

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