Rupee may hit 74.5 in medium term; USD-INR volatility jumps, Dollar index repeats 2018 performance

Updated: March 09, 2021 3:29 PM

The upswing in risk aversion on the bond has increased demand for the greenback and hence we could see DXY moving higher

rupeeThin margin exporters are advised to cover near 73.30-40 levels and wait with the stop loss of 72.80 on closing basis

By Amit Pabari

The US dollar, being a fiduciary currency, has its own significance across the globe. The higher liquidity of the US dollar is supportive for the equity, whereas shortage creates havoc in the market. As we know that intermarket analysis plays a vital role, the formulas between two currencies are not only dependent on two country’s economic performance but also on other countries too. The easy liquidity in the market supported by ultra-loose monetary policy by major central banks post pandemic levels kept reflationary trade higher. By keeping interest rates to “0-level”, central banks started to flood the market with liquidity – has helped drag down the cost for non-dollar-based investors of hedging the currency risk on their holdings of Treasuries. This erased demand for the US dollar and we had seen the Dollar index falling from a high above 103.50 in March, 2021 to 89.20 in January, 2021. Below factors from the US front are positive for the Dollar index (DYX) along with mixed to negative factors from counterpairs.

Dollar Positives:

Higher Yieldflation (Yield+inflation):

Recently, the 10-year benchmark bond yield was seen jumping sharply above 1.5% post Powell’s testimony, where he suggested that inflation should move up as the economy reopens. Till his last speech in testimony he was having a softer tone for the inflation and the bonds market priced in the highest five-year inflation expectations since 2008. But outperforming nominal Yield has narrowed down real yield from -1% in Jan, 2021 to currently -0.66 which suggests flight of capital toward the US to take higher yield advantage. Earlier this advantage we were seeing in India and other emerging markets and inflows were high. Furthermore, the US 10-year borrowing repo rate, which is typically positive, has been negative over the last many days and hit as low as -4.25%, suggesting stress in the bond market. The upswing in risk aversion on the bond has increased demand for the Greenback and hence we could see DXY moving higher.

Fed’s Lift-of is data dependent

Recently released data suggests that manufacturing activity is hot, but the service industry is still lagging. Prelim GDP for Dec-2020 is upbeat at 4.1% and retail sales data was robust above 5% mark. Further, commodity super cycle would definitely pick up inflation levels in upcoming time and hence inflation likely to remain higher. The official Non-farm payroll suggests addition of 379K in Feb vs 166K in Jan, unemployment ticked slightly lower to 6.2% and hourly earnings jumped to 0.2%. This all in one basket suggests strong recovery from pandemic. But Fed wants to lag behind and confirm twice before lifting off ultra-loose monetary policy and move hawkish. The stronger data is quite supportive for the dollar index.

Stimulus and vaccine optimism drives equity but risk of inflation is eyed

The U.S. stock benchmark’s earnings yield is just about 1.7% above 10-year yield rates — the smallest advantage in three years. Overvalued equities led by passage of Biden’s $1.9 billion stimulus and stronger vaccine rollout programs in the US, are now under pressure of rising inflation. In the commodity market, super-cycle Bull Run has been established. Copper price at 10-year high, WTI crude above $65 on OPEC’s extension of supply cut and freezing weather in the south US, rising globally raw material prices will contribute to inflated inflation levels. The reflationary trade seems receding and inflationary pressure will grab flows in treasuries and so US dollar.

Considering the above fundamental factors as the US is pouring hot money into the economy despite strong recovery, leading to a double-digit US nominal growth. This will lead to skyrocketing US dollar and possibly seeing a triple-digit US dollar index in the upcoming months.

Implications of positive US dollar on Rupee

2018 replica for dollar index and trend reversal for Rupee

Trump’s Trade war had shaken the world in 2018 and DXY had given a breakout on higher side post bottoming near 88.20 mark. This time, it seems the repetition of 2018’s trend and this time it is bouncing from a low near 89.20. The breakout above 91.50 sets a target of 94.80-96.00 in the next 2-3 months. If it moves further higher, then the triple digit figure can be seen on the chart. On the domestic front, the unwinding of the longest and richest carry in Rupee along with RBI’s plan of yield and liquidity control could not allow investors to have excess return furthermore. The demand for dollar ahead of financial year closure and importer’s revision in hedging plan to buy on dip could not allow the pair to move below 72.30-72.50 mark. The odds are in favour of the upside reversal in USDINR and the bullish dollar index will add further fuel in the rocket as suggested in the below chart.

Rupee, dollarThe odds are in favour of the upside reversal in USDINR and the bullish dollar index will add further fuel in the rocket as suggested in the chart

Strategy:

Strategy for Thin margin exporters:

Thin margin exporters are advised to cover near 73.30-40 levels and wait with the stop loss of 72.80 on closing basis or costing levels whichever is higher and maintain 80%-100% hedge ratio.

Strategy for Thick margin exporters:

Thick Margin exporters having new orders are suggested to sell around 73.50 levels and can maintain a stop-loss of 72.80 levels on closing basis and maintain a hedge ratio of 45%-55%.

Strategy for Importers:

Importers can buy their import payments up till April end in the range of 72.80-73.00 or they can hedge through buying risk reversal options (buy At the money call and sell Out of Money Put).

(Amit Pabari is managing director at CR Forex Advisors. The views expressed are the author’s own.)

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