After showing a notable gain of 3.7% in June, the Indian equity market, like its emerging market counterparts, has languished for most part of July. The sluggish behaviour of the Nifty after surpassing the 5,300-mark in the first week of July has come on the back of the US Dollar Index ? the gauge of the US dollar?s strength against a basket of six major currencies including the euro, British pound and Japanese yen ? striding towards a two-year high.
The latest gain in the Dollar Index has been fuelled by recently released minutes of the US Federal Reserve meeting which confirmed the central bank?s wait and watch approach towards the next round of quantitative easing (QE). The release showed that lesser number of committee members thought that more asset purchases should be carried out in the near future to boost the economy. The minutes showed that several committee members noted that ?… additional policy action could be warranted if the economic recovery were to lose momentum, if the downside risks to the forecast became sufficiently pronounced, or if inflation seemed likely to run persistently below the committee?s longer-run objective.?
Following the release, the Dollar Index jumped to 83.82 on Thursday, its highest since mid-July 2010. On the other hand, the MSCI emerging market index lost 2% to close at 914.07 while the 50-share Nifty declined by 1.3% at the end of Thursday?s session, its lowest in more than two weeks. According to a JPMorgan note, the Dollar Index could go as high as 84.9 as it has already moved past a key level of 83.55.
The Dollar Index not only gives a fair perspective of the overall value of the greenback as opposed to that against a single currency but also highlights the safe haven status of the US currency. Because of its position of a refuge currency or asset class, it also holds a strong negative correlation with the global equity markets.
In the recent past, especially since the bear market of 2008 post-Lehman collapse, it has been observed that a substantial rise in the index, which generally follows heightened uncertainty in the global financial markets, weighs more on the emerging markets than developed markets. This trend also confirms that the risk aversion among global investors has a higher impact on the emerging market equities given that a higher risk is attached to these markets in general.
Since July 2008, whenever the Dollar Index has appreciated by more than 10%, the MSCI emerging market index has underperformed the MSCI world index by a margin of 0.5% to 10%.
In the latest instance, the Dollar Index has appreciated almost 15% since its April 2011 low after the European Central Bank (ECB) changed its stance towards lower interest rates on the back of heightened concerns over the Europe?s sovereign debt problems. In the same duration, while the MSCI world index lost 13% of its value, the MSCI EM index fell by 24%.
