25 Feb 2019

Dovish Central Banks Drive Currency Markets Last Week

The INR ended the week higher against USD on heavy foreign capital inflows after growing expectations that the Federal Reserve would keep interest rate on hold this year.

author dp
Team INRBonds
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The INR ended the week higher against USD on heavy foreign capital inflows after growing expectations that the Federal Reserve would keep interest rate on hold this year. However, gains in USD during later part of the week ahead of the US-China trade talks and surging crude oil prices kept INR gains in check. INR appreciated by 0.18% against the USD last week and depreciated by 0.31% against the euro.

Further, the release of MPC minutes suggests that the RBI is going dovish under the new governor Shaktikanta Das and increases the possibilities of more rate cuts to accommodate growth concerns as inflation cools off. According to the minutes of the MPC meeting released on Thursday, Ravindra Dholakia, part of the six-member MPC, said there was space for about 60 basis points repo rates cut, as the central bank’s headline inflation forecast for the year ahead turned out to be less than the target of 4% for the first time.

USD ended the week lower after dovish comments from a Federal Reserve member puts downward pressure on USD, and despite the release of a broadly balanced set of minutes from the Federal Reserve’s last policy meeting that indicated that interest rates could still rise later in the year if the current uncertainty over the economy clears. Further, the gain in British pound amid strong labour market data and hopes for progress on upcoming Brexit talks puts additional pressure on USD.

USD Index (DXY), which tracks the movement of the USD against six major currencies, fell by 0.60% on a week on week basis and is at a level of 96.51. British pound appreciated by 1.87% against USD last week.

USD started the week on a higher note on Monday amid hopes that the U.S. and China will find a way to de-escalate their trade war. However, USD turned lower on Tuesday after dovish comments made by Federal Reserve member. Cleveland Fed President Loretta Mester, normally considered to be one of the Fed hawks, stated that she would favour slowing down the balance sheet normalization process.

Mester’s remarks joined a wider chorus from the central bank as recent signs of economic weakness, including the largest decline in retail sales in nine years, have forced policymakers to reverse course from a previously more aggressive stance in favour of policy tightening.

Further, the release of the minutes from the Federal Reserve strengthened expectations that the central bank will leave interest rates on hold this year and expressed a willingness to end its balance sheet unwinding program later this year. The Fed has been allowing as much as USD 50 billion a month of maturing securities to roll off its balance sheet, which peaked at roughly USD 4.5 trillion in Jan. 2015, but has now narrowed to about USD 4 trillion.

British Pound appreciated last week after an upbeat statement following a meeting between Prime Minister Theresa May and European Commission President Jean-Claude Juncker. The statement revived hopes that a ‘no-deal Brexit’ can be avoided at the end of next month, despite increasing signs of political disarray in the U.K. Reports suggest that May is coming under increasing pressure to push back the March 29 date when the U.K. is slated to leave the EU.

Weekly Global Bond Market Analysis

The 10-year US treasury yield has been in a range between 2.6% and 2.8% for most of the days in 2019. US 10-year benchmark bond yields were unchanged at 2.66% week on week. Reuters report suggests that U.S. and Chinese negotiators have begun to outline a deal to end the trade war, Bond yields also saw modest rise after minutes of the Federal Reserve’s January policy meeting showed policymakers are divided over the criteria for future rate increases. Few officials argued that rate increases might be needed only if inflation outcomes were higher, while other officials argued it would be appropriate to raise the federal funds rate later this year if the economy evolved as they expected. On Federal balance sheet reduction, almost all the participants wanted to stop reducing the balance sheet later this year.

Germany 10-year benchmark bond yields were unchanged at 0.10%. German PMI numbers showed a mixed picture, with the services sector accelerating to a five-month high, compensating for the second successive monthly contraction in manufacturing.

Japan 10-year benchmark bond yields fell by 1 bps after BOJ offered to buy 660 billion yen of 5-year to 40-year JGBs. The central bank regularly purchases JGBs from the market as part of its yield curve-controlling scheme. Japan core consumer inflation rose 0.8% in January 2019 in line with market expectations.

Italy 10-year benchmark bond yields rose by 7 bps after data showed industrial orders in Italy dropped 5.3% in December over the same month in 2017. Fall in industrial orders ended the bull run in Italian bond prices which were rising due to expectations for a fresh round of cheap multi-year loans for banks by the ECB.

Greece 10-year benchmark bond yields fell by 1 bps, Portugal 10-year benchmark bond yields fell by 7 bps, Spain 10-year benchmark bond yields fell by 7 bps.

Emerging economies 10-year benchmark bond yields were mixed last week.

Indonesia 10-year benchmark bond yields fell by 7bps, Bank Indonesia kept its interest rate unchanged and maintained its seven-day reverse repo rate at 6%. The central bank also pledged to continue its efforts to ensure adequate liquidity in the banking sector to encourage loan growth this year.

Australia 10-year benchmark bond yields fell by 5 bps, Australia job data suggest employment rose by 39,100 in January, beating the estimated increase of 15,000 over the month by a big margin. The jobless rate remained unchanged at 5%.

South Africa 10-year benchmark bond yields fell by 18 bps, Brazil 10-year benchmark bond yields rose by 25 bps, Russia 10-year benchmark bond yields rose by 15 bps.

US benchmark Junk bond yields fell by 10 bps to 6.59%, Euro benchmark Junk bond yields fell by 14 bps to 3.86%.