Dollar to strengthen says a Research firm

Dollar to strengthen says a Research firm

Posted by- Neelam Mathews

July 11, 2011

A Research firm not wanting to be quoted says the Dollar likely to strengthen in 2HFY12E.

While the ECB has already raised policy rates by 50 bps this year, the Fed has shown no intention of exiting from its accommodative policy stance in the immediate future. With interest rates differentials turning against the Dollar, the universal currency is expected to remain under pressure in the near term.

However, the large uncertainties in the global arena with respect to the sovereign debt crisis as well as growth slowdown fears will see FX markets range-bound in the near term. Since the QE2 proved to be Dollar negative on widening interest rate differentials, an exit by the Fed from its accommodative policy stance will likely result in a firm Dollar as interest rate differentials will tend to narrow. We expect the average for EUR/USD at 1.43 in 2QFY12E, 1.39 in 3QFY12E and 1.35 in 4QFY12E, taking the overall average for EUR/USD for the year to 1.40 from 1.32 in FY2011.

Near-term INR strength to give way to modest depreciation in the medium term

In the near term, it expects USD/INR to consolidate around current levels with a bias towards a mild appreciation. The recent improvement in global risk sentiment as Greece narrowly escaped a default boosted the Indian Rupee. The Rupee is also expected to draw support from a likely pickup in equity flows in the coming months as the government initiates on crucial reforms and begins with its divestment process. Additionally, the continued strength in the export sector is also likely to aid the domestic currency. “We expect USD/INR to average 44.25 in 2QFY12E. However, in 2HFY12E, we expect the Rupee to depreciate and average 45.00, given our expectation of a Dollar rebound during this time”.

Risks

The high level of uncertainty in the global economy has translated into volatile trends in the currency market, making it difficult to gauge the momentum in currency markets. Our currency views could be at risk in case there is any deviation from our base case assumptions. Some of these risks relate to (1) RBI tightening the monetary policy much more than currently anticipated if inflation were to remain stubbornly high. This would dampen the investment sentiment and weigh on the domestic unit, (2) global crude oil prices were to climb up once again and sustain at elevated levels. This could unleash macro-stability risks, (3) European debt crisis could get intensified and culminate into a Greece default and/or need for a bailout to other PIGS countries, and (4) the US economy decelerates sharply and/or enters into a recession, which prevents the Fed

from a year-end exit.

Economy

Currency:

FY2012E INR: Another year of ranged trading. We expect FY2012E to be a repeat of FY2011 for the Indian Rupee, and the USD/INR is likely to be locked in the 44.00- 46.00 range for the greater part of the year. In the near term, the USD/INR is expected to consolidate around the current levels as risk appetite remains buoyant. Additionally, a pick-up in flows as well as strong export growth is likely to support the domestic currency. The near-term strength is likely to give way in the medium term and USD/INR is expected to head towards 45.00-46.00 in 2HFY12E. For FY2012E, we estimate USD/INR to average around 44.75.