August turned out to be a pretty whippy month in the FX markets for USD-INR. It had started off bullish by continuing with a rally that had begun in the second half of July- from 81.65 levels, and really took off in the first few days of August to hit 82.70 plus levels, before pausing. Mid-month the pair blasted a hole above 83.00 and traded towards 83.25 before strong RBI intervention brought the market lower. It remained above 83.00 for quite a while before a strong sell-off plunged the pair momentarily to 82.35 where buyers came in again and reinstituted a minor Dollar uptrend into the month end.
The fact that it traded comfortably on the 83 handle from the 14th through to the 23rd has made the market nervous about the RBI’s intentions. The accepted trading range mindset from October 2022 was that the RBI was not happy or comfortable to see the Rupee trade weaker than 83.00 to the Dollar broadly (slight infractions were allowed at first but later even approaching it was not really tolerated). Since the October 2022 peak there had been 5 attempts to see the limits of tolerance and it was only on the 14th of August that the Rupee breached previous peak. Despite all the talk of the imminent de-dollarisation of the currency markets and the end of US rate hikes that have been supporting the US currency this ‘feels’ like the currency pair is moving on to a slightly higher register.
Fig. 1: USD-INR 1 year
Source: Investing.com
Whilst the factors that have led many investors and market observers to predict the demise of Dollar primacy have only advanced further the strength of the US Dollar at the moment stems from short-term factors that are boosting it against the other majors. A major part of that strength lies in the robustness of the US jobs market- even more than US inflation, which has been largely tamed (the last price rise print came in at 3.3%). But even this level is still not good enough for Federal Reserve President Jerome Powell who recently announced at the Jackson Hole Symposium for central bankers that they were still maintaining their target of 2%- and that they would keep rates high or take them higher if needed, to bring inflation to their target- by attacking demand. This is providing one underpinning for Dollar strength.
Possibly the strangest thing that led to Dollar buying last month was the news of the downgrading of sovereign US long-term debt by Fitch to AA+ who have cited concern over fiscal deterioration over the next three years and the repeated debt ceiling hikes that allowed it. The reaction from the market was to move into US sovereign debt and the US Dollar in a bout of ‘safe haven’, risk-off buying. So, the markets bought Dollars when it heard that the government backing it had a weaker standing in the credit markets. This was actually a thing that happened last month and it highlighted how utterly critical a role the use of the Dollar is in the world’s financial systems.
Other than the strength of the US economy the other factor that played a role in the Dollar’s rise through the month is the weakness of the other major economies. Of great concern now is the surprising weakness of Chinese economic growth as their property/ debt crisis worsens. The reporting of Chinese growth data and news of likely debt defaults pushed the US Dollar above 7.30 Yuan as China (and Japan) were seen to continue their low interest rate policies and that investors would start selling their holdings in Chinese firms (Goldman Sachs and Morgan Stanley have cut their targets for equities there and investors have pulled out more than US$ 10 billion in the week since the data was announced). Since China is as interlinked to the world in trade (see below) as the US Dollar is to the settlement of that trading this is expected to affect global growth as trade volumes fall, commodity prices are affected, deflation gets exported and so on.
Fig 2: Chinese trade Connections across the world
Even Europe is starting to look ragged with fears of stagflation (low growth plus high inflation) mounting even as China faces the opposite problem with prices. This is increasingly making the US look like one of the few remaining good investment destinations and it seems that the US stock market will outperform in the remaining months of 2023. This, of course, adds to the lustre of the Dollar in the short-term.
This all is separate from the fate of the Dollar in the medium to longer-term. The likelihood is that US rates are likely to remain here or move up by 25 basis points by year end whereas the UK and Europe are more likely to see further hikes, thus making the Dollar less attractive for yield play. The scenario will likely kick in at the start of 2024 ushing the Dollar lower again.
And we can’t forget the recent conference in South Africa where the BRICS 5 became the BRICS 11 as 6 new nations joined. Given that Saudi Arabia, the UAE and Russia are now part of the BRICS grouping there may be a declaration of intent sooner rather than later of the availability of oil pricing and payment in currencies other than the Dollar- perhaps the Yuan. We know that India, China, and Russia are all working on systems architecture to help them bypass US/ European controlled settlement systems (like SWIFT); bonds rolled out in Indian Rupees and South African Rand are in the pipeline. All these measures will slowly chip away at the centrality of the US Dollar and the premium attached to it will be eroded. But a new BRICS currency is unlikely in the near future so the US currency is likely to be a mainstay for a while yet.
Looking at the INR to weaken marginally as the Dollar gains in the coming months. It almost always weakens ahead of general elections anyway but it looks like most of it is behind us already. The most probable scenario then is that the range gets slightly altered from 82-83 to 82.50-83.50. Good economic data out of India will keep the Dollar capped and RBI support will act as a base.