Rupee gained on weaker dollar

Indian Rupee has for the fourth week in a row, after touching 83 levels in December 2022. A sharp fall in the greenback amid prospects of a Fed pivot coupled with ease in US treasury yields aided the domestic currency. Yield differentials between India and US have been an important factor determining the Rupee trend. The Rupee 12M forward premiums, a proxy for the differentials have edged higher, in the past weeks, proving an upper hand to Rupee against the dollar. Still, Rupee has largely been an underperformer relative to the peers.

FIIs have been selling for most of the trading sessions so far in 2023. Reopening in China has prompted funds to go overweight on Chinese stocks, which are trading at cheap valuations, leading to outflows from domestic securities. FPI net investments have seen almost Rs.15,000 crore outflows in January 2023.  

India’s foreign exchange reserves rose by $10.47 billion to $572 billion in the week through 13th January, the highest level since early August last year. Meanwhile, RBI bought USD for the first time in 5 months, in Nov 2022. RBI January Bulletin showed that the central bank bought a net $4.3 bn in the spot, during Nov 2023 (In Nov, the Rupee spot touched 80.5 levels, which might have prompted the central bank to buy).

The dollar index fell almost 0.2% in the previous week and closed near a seven-month low of 102 levels. US Retail sales data released last week showed a decline of 1.1%, while, US PPI plunged to 6.2% year on year in December, reinforcing the fact that the economy is facing a slowdown. Federal Reserve Governor Christopher Waller, one of the most hawkish officials, has joined the other policymakers in backing a smaller pace of rate hike during the February meeting. Waller’s speech was the last scheduled public comment before the US central bank enters the quiet period. Adding to the pressure, ECB officials came in with some hawkish guidance and telegraphed multiple 50 bps rate hikes in coming meetings.

Outlook for the week 

As we are moving into a risk-averse week ahead of a slew of central bank meetings, some weakness in Rupee could be warranted. Domestic bond yields may move marginally higher due to worries about yet another year of elevated borrowing during the Union Budget on 1st February. Still, the USDINR outlook remains a sell-on rise on a positional basis, as we expect a further correction in US yields and risk sentiments returning to the market after 2nd February.

The dollar index also looks weak, as investors are expecting a pause after one or two hikes amid the backdrop of easing inflation and a slowdown in the US economy. Interest rate futures are pricing in two 25 bps rate cuts in 2H 2023. The greenback generally starts falling well before peak fed funds and that is what we have been seeing lately and the trend is expected to continue. The Fed might increase interest rates by 25 bps during the February meeting, taking the funds rate to 4.5% – 4.75%. Amid the recent loosening of the financial conditions, we expect Fed chair Jerome Powell to be hawkish in his statements as usual and give the case for higher rates for longer, which markets might likely shrug off.

The Bank of England and ECB meeting outcome on 2nd February might add to next week’s volatility. Both the central banks are expected to deliver a 50 bps rate hike in the coming meeting. However, ECB officials might telegraph that more 50 bps hikes are on the table for the future, as they have been a late entrant to the hiking cycle and Eurozone inflation still hovers near decade highs. Whereas, BoE is nearing terminal rates and we might see some underperformance relative to Euro.


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