Rupee seems to have reversed the recent divergence with the dollar index, tracking gains in Asian currencies. Yuan gained on China’s reopening, while Yen was aided by the BoJ policy shift. Broad risk-on sentiments amid prospects of a Fed pivot also helped the domestic currency.
An uptick in Rupee 12M forward premiums is also rendering some support. Forward premiums increased to 2.27% in January 2023, from a 14-year low of 1.6% in December 2022. Recent ease in US CPI coupled with hawkish comments from the RBI governor led to the narrowing of the interest rate differentials.
Meanwhile, FII’s have been selling throughout January, as major funds have been turning overweight on China amid a complete reopening from the zero covid policy. FPI net investments have seen outflows of more than Rs.19,800 crores so far in January 2023. On the economic data front, India’s inflation unexpectedly eased to 5.72% in December 2022 from 5.88% in November, pointing to the lowest reading since December 2021 and staying below RBI’s upper tolerance level of 6%.
The dollar index fell in the previous week and has lost more than 11% from a 21-year high of 114.77 touched in September, on prospects of a Fed pivot. US CPI data for December showed that year-on-year inflation eased for the sixth month, while the month-on-month inflation fell for the first time since May 2020, improving the conviction that the Fed might slow the pace of rate hikes and is nearing terminal rates. While some Fed officials have warned that rates still need to go significantly higher to control inflation, Fed Bank of Boston President Susan Collins and Philadelphia’s Patrick Harker both advocated moving to a smaller 25 basis points rate hike at the February meeting.
US Retail Sales and Bank of Japan monetary policy in focus for the week
India’s trade deficit data for December showed that the deficit widened to USD 23.76 billion in December 2022 from USD 21.68 billion in the same month last year. Exports fell 12.2 percent from a year earlier to USD 34.48 billion, amid weakening global demand, while Imports were down 3.5 percent to USD 58.24 billion, as domestic demand was also hit.
Meanwhile, core inflation remains sticky at 6% and the central bank has more work to do on the interest rate front. We expect RBI to increase rates by another 25 bps in the February meeting, taking repo rates to 6.5%
US one-year inflation expectations fell to an 18-month low of 4% in January. Amid the backdrop of easing inflation and cooling the economy, fed funds terminal rates might stand at 4.9% by March 2023. Bond markets are also pricing in two 25 bps rate hikes by year-end. The overall trajectory for the dollar index remains on the downside.
Investors will be closely watching the Bank of Japan policy outcome due tomorrow. Markets are expecting some hawkish policy tweaks from BoJ. In case BoJ fails to meet market expectations by maintaining the status quo, then we might see some short-term weakness in Yen and short covering in the dollar index. US Retail sales and Eurozone inflation will be important economic data for the week.