US Dollar to lose momentum; Euro to recover: Nirmal Bang

Nirmal Bang has come out with its report on currency quarterly outlook. According to the research firm, the rise in inflationary expectations on onset of QEIII is likely to push the US benchmark note yields higher which is likely to favor dollar against the Japanese Yen.

After a string of policy responses from the Central banks of the developing world, it is turn of Central banks from the developed world to put their foot forward after keeping mum for quite some time. We expect a whole lot of monetary policy responses in the next two months, the father of all could be the announcement of another round of quantitative easing from the US Federal Reserve. The likelihood of this event is likely to put the US dollar on a downward spiral against major currencies like euro, pound and Australian dollar. Among other policy actions, the prominent ones could be a 25 basis point rate cut by European Central Bank and an expansion in quantitative easing by Bank of England (Known as Asset Purchase facility). A section of market also expects the ECB to consider another round of Long Term Refinancing Operation (LTRO) for three years. However, we believe ECB would opt for a rate cut to boost the credit flow from the banking system and support the faltering economy. Going with LTROs will further inflate the loan book of ECB and it may not be willing take any more of these unsecured loans on its book. The politicians at the European Summit has responded well by taking some bold steps, to let their rescue fund inject aid directly into stricken banks from next year and intervene on bond markets to support troubled members like Spain and Italy. Euro to recover ground
The relatively surprising outcome of the EU Summit is a good step forward and seems to have a stronger effect. Now the ball moves in ECB’s court where Mario Draghi has a chance to contribute to stabilization with the rate cut and perhaps more steps, after he got action from the governments. Since the upside risk in price rise has been ruled out by ECB, it also gives ECB cushion to act on policy rates. In addition to a 25 basis point cut in interest rates, ECB can also go to extent of reducing deposit rates to zero levels which is currently at 0.25 percent. We believe that a 25 basis point rate cut is already discounted in euro and benchmark bond prices which will prevent any significant downside in euro from the current levels. Perhaps, a rate cut will improve the prospect of credit flow to business in euro zone, leading to pick up in economic activity. With the stabilization in peripheral yields coupled with improvement witnessed in euro zone benchmark yield, yield equation is likely to remain supportive for euro. Where is rupee headed?
True, the fundamentals remain weak for the rupee as long as concerns on twin deficits (current account deficit and fiscal deficit) remain unanswered. However, one can’t deny the fact that the markets have overreacted to the situation and pushed rupee in undervalued zone. Going forward, our base case scenario is that India will receive capital inflows in the coming months backed by another gush of liquidity released by the developed world and a seemingly stabilizing euro zone in short-term after the outcome of EU summit. Perhaps, any such event will allay the concerns of financing current account deficit. Moreover, we also believe that we are heading close to some swift policies from government and RBI to prop up the rupee after lifting foreign investment cap in G-sec by $5 billion. Issue of NRI bonds/ direct dollar sale to oil marketing companies (OMCs) and pushing some reforms on allowing FDI in select sectors are some moves on the cards. Rupee can also take some comfort with the expected self-adjustment in current account deficit on the back of a decline in non-oil imports especially gold imports in Q2 FY13. As far as monetary policy is concerned, we believe RBI will hold on to the current stance of not lowering the policy rates as long as inflation remains sticky and the government policy deadlock is not resolved to an extent. On this count, high interest rates are likely to extend support to the rupee. Driver of Japanese Yen: Safe-haven trade or carry trade?
Japanese Yen has been driven mostly by safe-haven trades of late. However, Yen could undergo a regime shift from safe-haven trades to Yen carry trades in Q2 FY12. The basic underlying of this shift could be a rise in yield differentials if further monetary easing from the US in the form of QE III pans out in the near future. The rise in inflationary expectations on onset of QEIII is likely to push the US benchmark note yields higher which is likely to favor dollar against the Japanese Yen. Short-term currency strategies: Buy USDJPY @ 79.50 for a target of 82.00 SL below 78.50
Sell USDINR @ 55.50-55.75 for a target of 53.00 SL above 56.75
Buy EURUSD @ $1.2450-1.2500-for a target of $1.3000-1.3100 SL below $1.2300 Disclaimer: The views and investment tips expressed by investment experts/broking houses/rating agencies on moneycontrol.com are their own, and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions. To read the full report click on the attachment

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