INR has traded with a weakening bias as less dovish market
expectations for Fed policy has boosted the USD and US
rates, pressuring India's ability to fund its current account
deficit. Though oil and gold prices have eased, the external
deficit is unlikely to fall enough to nullify external funding
risk for the rupee, particularly if the market's bias for pricing
in a less dovish Fed to the USD continues. Capital account
inflows following policy rate cuts have thus far failed to
support the INR on a sustained basis.
EUR-INR JUN
Stronger dollar, an ECB interest rate cut, a building
discussion on the potential of negative interest rates and a
large EUR short position (reported by the CFTC).
JPY-INR JUN
In May the yen reached a 4.5 year low having been
pressured by aggressive Bank of Japan policy juxtaposed
against rising expectations that the Fed would begin
stepping away from QE.
GBP-INR JUN
Bearish technicals and a broadly stronger USD all
contributed to GBP weakness in May. Outlook remain bearish
viewing the combination of low growth, elevated inflation, an
upcoming change in leadership at the BoE and negative
sentiment as GBP negatives.
The Reserve Bank of India continues to provide monetary stimulus, although at a cautious pace, in order to stimulate sluggish economic activity; on May 3rd,
monetary policymakers lowered the benchmark repo rate by 25 basis points (bps) to 7.25%, taking cumulative reductions to 75 bps since the beginning of the
easing cycle in January. The authorities identified two key factors behind the decision: a continuous and steep deceleration in economic growth, and an easing
in WPI inflation closer to the central bank’s tolerance threshold. While the policymakers pointed out that there is little space for further monetary easing,
market assess that the fact that wholesale price inflation weakened substantially to 4.9% y/y in April from 6.0% the month before will allow further modest
reductions in the benchmark interest rate. India’s economic performance remains subdued, challenged by a high cost of financing, constrained fiscal room and
subdued global demand conditions. A gradual improvement is in sight, however, supported by monetary easing and the government’s attempt to implement
modest economic reforms. Market is rumored with revised India’s real GDP growth forecasts downwards and now expect the economy to expand by 5½% in
2013, followed by a 6% gain in 2014. Shifts in investor sentiment will continue to be reflected in the value of the Indian rupee, as the country suffers from a
large current account deficit (equivalent to around 5% of GDP in 2013), a negative sovereign credit rating outlook (affirmed by Standard & Poor’s in May),
weak government finances, and political instability.
Market Roundup
Global markets turned jittery after Congressional testimony by Fed Chairman Ben Bernanke and minutes from the FOMC's latest policy meeting
seemed to send conflicting messages. The markets were a bit flummoxed as the Chairman predictably cited "premature tightening" as a risk to the
recovery before saying later that the Fed could begin to dial-down purchases at "one of the next few meetings." However, the Fed minutes released
same day showed "a number of participants" are prepared to slow QE as soon as June.
U.S. initial jobless claims fell to 340,000, a decrease of 23,000 from the previous week's revised figure of 363,000. Economists had expected jobless
claims to drop to about 345,000. US new home sales climbed 2.3% to a seasonally adjusted annual rate of 454,000 in April from the revised March
rate of 444,000. Economists had expected new home sales to increase by 1.9%.
Eurozone consumer confidence indicator came in at -21.9, up from April's score of -22.3. Economists were expecting a reading of -21.8 for May. The
latest reading is the highest since July 2012. Eurozone composite output index, that measures performance of the both manufacturing and service
sectors, rose to 47.7 in May from 46.9 in April. Economists expected the reading to rise to 47.2. German composite output index rose to 49.9 in May
from a five-month low of 49.2 in April.
French Purchasing Managers' Index for the service sector held steady at 44.3, the manufacturing PMI rose to 45.5 from 44.4 in April. Economists had
forecast the services index to rise to 44.5 and manufacturing index to reach 44.7. The Economic and Monetary Union (EMU) is a more stable union
today than it was a year ago, European Central Bank President Mario Draghi said. Also "markets are fully confident that the euro is a strong and stable
currency," he said in a speech in London.
German Ifo index of business confidence rose to 105.7 in May from 104.4 in April and beat estimates of 104.5 reading.
China's HSBC flash PMI fell into contraction territory for the first time in seven months in May, dropping to 49.6 from 50.4 in April, missing
expectations. “The cooling manufacturing activities in May reflected slower domestic demand and ongoing external headwinds. A sequential slowdown
is likely in the middle of Q2, casting downside risk to China's fragile growth recovery. Moreover, the further signs of labor market slackness call for
more policy support. Beijing still has fiscal ammunition to do so." HSBC Markit said.
The Bank of Japan decided to keep its monetary easing program unchanged from that announced in April and said the economy has started to pick up.
EURO ZONE - First-quarter GDP figures released this month for the euro area highlighted the enduring economic weakness in the region. The
results fell short of market expectations, particularly in the case of Germany, where both investment and exports declined sharply during
January-March (just offset by an expansion in household spending and larger drop in imports). The ECB’s expected 2013 H2 recovery still
appears far off, and recessionary conditions could well persist into the second quarter. The fact that several key developed and emerging
markets also appear sluggish – prompting a new wave of monetary policy stimulus – suggests that global growth momentum is gathering
speed more slowly than earlier anticipated. Recent weeks have seen increasing acknowledgements by policymakers regarding the absence of
a forthcoming recovery and the inability of crisis-ridden states to return to growth amid severe fiscal austerity. Even the German Finance
Minister has called for urgent action on youth joblessness, championing proposals for bilateral aid agreements with Germany’s troubled euro
zone partners. A slight uptick in the PMIs in May was a welcome development, but may prove to be an aberration, in which case the ECB may
be compelled to implement another interest rate cut (following the quarter-point reduction to 0.50% in May). Inflation is expected to rebound
somewhat after a steep decline in April, though price pressures will remain subdued through 2014.
The pound showed renewed weakness in May, with losses amounting to roughly 3% versus the US dollar reflecting weak economic data and
the general bias toward USD strength over the month. Despite the rebound in output in the first quarter (the preliminary GDP estimate
confirmed growth of 0.3% q/q in January March, following the prior quarter’s 0.3% contraction), there are few indications that the economy is
entering a meaningful recovery. The gain was driven almost entirely by a large build-up in inventories, with a small addition from household
spending. Meanwhile, private investment and exports continued to detract from growth. Disappointing retail sales data for April suggest that
consumer spending is losing steam. The fact that the government’s promised ‘rebalancing’ toward investment and trade has yet to materialize
has prompted calls for a tempering of fiscal consolidation plans. According to the IMF’s latest Article IV Consultation report on the UK
(released May 22nd), of the GBP130 billion in deficit reduction measures slated for FY 2010/11 to FY 2015/16, more than half have already
been implemented. The report also supported an expansion of the Bank of England’s (BoE) asset purchase program and use of forward
guidance by the central bank, and stressed the return of the two state-intervened banks to private ownership in order to strengthen
confidence in the financial sector. Inflation dropped sharply in April, from 2.8% y/y to 2.4%. Much of the decline was due to temporary
factors, however, and is unlikely to cause any great shift in opinions at the BoE.
Market participants’ attention is centered on Japan’s economic performance in order to assess the effectiveness of the country’s recent
unprecedented monetary policy actions. Signs are emerging that policymakers’ revitalization efforts are starting to bear some fruit: earlier
improvements in confidence are translating into a pickup in household spending, while leading indicators point to increasing economic
momentum more broadly. In addition, the external sector should receive a boost from the recent substantial depreciation of the Japanese
yen. Nevertheless, an extended equity market correction could translate into deterioration in consumer and business confidence, potentially
erasing some of the recent improvements. The country’s real GDP increased by 0.9% q/q (non-annualized) in the first quarter of the year
following a 0.3% gain in the final three months of 2012. The growth was reasonably broadly-based with the exception of weak investment
activity. Market expect the economy to expand by 1.4% (1.0% previously), followed by a 1.5% gain in 2014. While the Japanese monetary
authorities seem determined to end deflation, inflation remains in negative territory for the time being (consumer prices declined by 0.9% y/y
in March). Market assess that the period of deflation will come to an end around mid-year, with inflation creeping gradually higher towards
1.2% y/y by the end of 2014. In light of the substantial monetary policy measures announced in April, market does not foresee any material
policy changes in the near term.
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