It’s advantage dollar, as currencies swing to the tune of central bank policies

It’s advantage dollar, as currencies swing to the tune of central bank policies

Currency swings, notably in the second half of 2021, are being driven by various stances of global central banks. A soft August non-farm payroll report and a dovish speech from Fed Chair Jerome Powell at the Jackson Hole have taken some of the sting out of the dollar on the upside. Accordingly, the rupee outperformed most in Asian emerging market basket in August.

However, the Indian currency then started retreating amid the ongoing spillover volatility due to the uncertainty over monetary normalisation by RBI. The latest move by the Indian rate-setter to absorb liquidity through the VRRR auction worth Rs 50,000 crore hinted at the first stage of monetary tightening.

Meanwhile, the dollar got some modest support against the rupee in the wake of strong buying by importers. However, the dollar flow momentum is not yet over. The rupee still remains the favourite carry trade counter in the EM basket, despite any possible outflows that can arise due to the concerns over the Delta variant.

As far as monetary tightening is concerned, it will be done gradually by the central banks, avoiding any major volatility due to policy divergence among themselves.

On the technical side, the rupee has a strong ceiling against the dollar around 72.80 while the floor can be around 74.40 followed by 74.80 in the coming months. We will remain negative on the rupee in the medium term based on the stronger dollar trend, which is likely to stay for the rest of the year.

The EUR-USD as well as EUR-INR pairs have come under pressure after the ECB shifted to a symmetrical 2.0% inflation target in late July. While it was not quite as aggressive as the Fed’s average inflation targeting, ECB’s new policy has still managed to drive real EUR interest rates down to new low and hit the trade-weighted euro.

As for the rupee, an appreciation in the Indian currency since late April this year has kept the euro-rupee pair lower. This comes at a time when the US Fed is preparing to normalise policy. With US jobs numbers likely to improve into October, the dollar can stay stronger versus euro in the coming weeks. We think the EUR-USD pair can stay in the 1.16-1.20 range going into the yearend, but risks are clearly skewed lower. The UK pound continues to follow a narrow range of 1.37-1.39 vs dollar since the last two months.

The sterling remains choppy within a range despite better-than-expected Nationwide House Price Index and Manufacturing PMI for August. Surprisingly, the pound lost its strength after the UK PM announced a tax hike to fund the budget deficit, which weighed on the currency amid fears that a recovery in the British economy may take longer than expected.

Additionally, markets are starting to take into account Brexit-related political risks associated with the end of the grace period at month-end September for the Northern Ireland-UK trade check issue. Technically, both euro and pound should fall in the coming months, which can lift the dollar index to around 94.80 by year end.

(DK Aggarwal is the CMD of SMC Investment and Advisors)

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