The USD has many positives going for it at present and that is feeding on drop in the value of the INR against the USD. The INR has dropped by over 2.3% against the USD over the last one month and is trading at five month lows of Rs 61.50 to the USD as of 6th August 2014. The USD strength will keep the INR down in the near term while in the longer term the improving macros of the Indian economy will lend strength to the INR.
USD looks strong on a fundamental as well as risk aversion factor. On the fundamental front, the US economy is seeing strong job additions to its economy with 1.5 million jobs added calendar year to date. Unemployment rate is down from 6.7% to 6.2% since January 2014. Inflation as measured by CPI rose by 2.1% in June while core CPI stripped of food and energy prices rose 1.9%. CPI was 1.7% last year and core CPI was 1.6%.
The Fed’s preferred measure of inflation, the core PCE (Personal Consumption Expenditure) was at 1.49% in June 2014 against 1.27% last year. Fed’s threshold level for PCE is 2% beyond which it will look to act if PCE long term trend is seen as rising.
The Fed is first withdrawing stimulus provided through asset purchases given that the US economy is showing signs of growth. The Fed has tapered its monthly bond purchases from USD 85 billion to USD 25 billion since December 2013 and will end its bond purchases by October 2014. However the Fed is still cautious on raising rates from record lows levels of 0% to 0.25% and has signaled rate hikes starting mid 2015.
The ECB on the other hand is facing prospects of deflation with CPI for July 2014 at 0.4%, down from 0.5% seen in June 2014 and down from 1.6% seen last year. ECB is looking to pump in liquidity through TLTRO (Targeted Long Term Refinance Operations) of Euro 1 trillion and Fed like bond purchases.
The markets are factoring in Fed rate hikes and ECB liquidity measures and have taken down the Euro by over 3% from levels of 1.39 to the USD to levels of 1.335 to the USD over the last few months.
The prospects of Fed tapering off bond purchases fully and starting to raise rates in 2015 is feeding into USD strength against other major currencies as well. The USD index that tracks the USD to a basket of six major currencies is up by over 3.5% over the last few months.
The USD is also benefitting from the current tensions in Ukraine, which is escalating everyday with Russia deploying its army at the border and also imposing restrictions on European Union flights over its airspace. Russia and other G7 nations standoff could lead to a wider turmoil in commodity and currency markets globally.
Risk aversion on Russia–Ukraine tensions is seen in rise in credit spreads of emerging credits. ICICI Bank (BBB- S&P) 5 year CDS (Credit Default Swap) spreads have risen by 25bps over the last one month on the back rising risk aversion. Apart from Russia-Ukraine tensions, debt default by Argentina (Click here to read about Argentina Debt Default) and Israel – Palestine fighting and Iraq internal wars have led to rising levels of risk aversion in global markets.
Equities have fallen from record highs globally with US indices of Dow and S&P 500 down over 3% and German Dax down over 8% over the last couple of weeks. Equity markets are giving up gains on prospects of Fed rate hikes and global risk aversion. Sensex and Nifty that touched record highs last month will follow global equities as markets take risk off the table.