Rupee skids on US Fed rate hike

Down 24 paise as Yellen also announces plan to unwind balance sheet

As widely expected, the US Federal Reserve on Wednesday raised the key interest rate by 25 basis points. In addition, the Fed announced its much-awaited plan to unwind its balance sheet and also retained its stance for one more rate hike this year.

The rupee, which broadly remained stable in the first half of trading on Thursday as this move was widely anticipated, could not sustain the momentum and fell to close at 64.54 to a dollar, 24 paise lower for the day.

Strong labour market

The Fed expects the job market to remain strong, stating that the strong labour force participation is a good sign. It expects the unemployment rate to remain at 4.3 per cent this year and move down to 4.2 per cent next year.

In March, the Fed had projected the unemployment rate to remain at 4.5 per cent for both these years.

On the growth front, the Fed expects the US to grow at 2.2 per cent this year, slightly higher than the 2.1 per cent projected in March.

But on the inflation side, the Fed has projected a slight slowdown this year. The inflation forecast has been revised lower to 1.6 per cent from 1.9 per cent projected in March.

However, the Fed has retained its stance to achieve the target inflation rate of 2 per cent next year. The Fed Chair, Janet Yellen, in her press conference insisted that the market should not overreact to the recent fall in inflation numbers.

She stated that the fall in inflation was due to a sharp fall in telephone bill related items and a sharp fall in prescription drugs. “We will be closely monitoring the numbers and will review our outlook accordingly,” said Yellen.

No more surprises

It was clear from Yellen’s press conference that the Fed definitely does not want to create any ripples in the global financial markets as had happened in 2013 on talk of tapering the quantitative easing (QE).

As a result, the Fed has revealed its initial plan for reducing its balance sheet on Wednesday, stating that it will begin this year.

“Our intention is to keep the market well informed about the plan on normalisation,” Yellen said. As a part of this, the Fed initially will cap its reinvestments in Treasury securities to $6 billion a month and in agency debt and mortgage-backed securities to $4 billion a month. However, the time for beginning this process is not yet decided and it is not sure whether the next rate hike and the balance sheet trimming will coincide in the same meeting.

Remains stable

The rupee has remained stable between 64 and 65 against the dollar for more than two months now. Within this range, the sudden fall on Thursday may keep the currency under pressure in the near term.

If the rupee stays below 64.50, a fall to 65 is possible in the coming days. Whether it falls further below 65 or not will then decide the next move.

A breakout on either side of 64 or 65 will give a clear cue on the next trend for the currency. A fall below 65 will increase the likelihood of the rupee weakening to 66. On the other hand, if the rupee breaks the range above 64, it can strengthen to 63.85 or 63.60.

FPI flows to support

One of the major factors that has been keeping the rupee strong is the inflow from foreign portfolio investors (FPIs). The Indian debt segment has witnessed a whopping $13.2 billion of inflows so far this year. The equity segment, on the other hand, has seen an inflow of $8.3 billion.

As there are going to be no major surprises from the US Fed, there is no threat of FPIs pulling out money from the Indian market, as had happened in 2013 that took the rupee lower to 68.85 levels.

While this trend of strong inflows continues, the rupee may remain supported which, in turn, may cap the downside in the currency.

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