Do you know there’s one asset rising to multi-decade highs? Can you guess which one it is? No, it’s not equities or cryptocurrencies!
It’s Greenback (U.S. Dollar). Surprise, surprise!
Why is the US Dollar So Strong?
According to the International Monetary Fund, the most widely used currency is the US dollar. It accounted for more than 60% of all known central bank foreign exchange reserves as of the fourth quarter of 2019.
Even though it lacks an official title, it is the de facto global currency.
The U.S. Dollar Index, which measures the greenback against a basket of six peers’ currencies, surged to above 109.29 Jul-22. Since late 2002 the dollar has been on the highest level compared to its peer currencies.
The dollar’s exquisite recent rise from below 90 levels last year comes amid the highest inflation in 40 years and surging U.S. bond yields, which helps a dollar appreciation.
Inflation is at a multi-decade high, putting pressure on the Federal Reserve to act more aggressively and tighten monetary policy. The yields on the 2 and 10-year U.S. treasuries each push to new decade highs.
Since the liquidity tightening cycle is coming back after a decade of a low-interest rate era, that’s not good news for stock-market investors.
Stocks are selling off as traders are expecting a higher risk premium with bond yields rising, the fear that these policy moves could cause a recession.
What is the U.S. Dollar Index?
The U.S. dollar index measures the value of the Greenback against a basket of six major worth currencies of the U.S.’s significant trading partners. These trading partners’ currencies are:
- Swiss Franc
- Japanese Yen
- Canadian Dollar
- British Pound
- Swedish Krona
The value of the Dollar index is a signal of the USD’s value in global markets. A higher value means stronger the dollar. After the Bretton Woods Agreement dissolved, the Dollar index was established in 1973 with a base of 100.
The largest component of the index is the Euro which is almost 57.6% of the basket, followed by the Japanese Yen with 13.6%, GB Pound has 11.9% weightage, and others.
Why is the Greenback Getting Stronger?
The Japanese Yen fell to ¥139.39 levels against the Greenback last seen in October 1998. The Yen is falling because the Federal Reserve, USA’s central bank, is tightening monetary policy.
Meanwhile, Japan is not changing the stance of its highly accommodative monetary policy. Interest differentials favor Dollar positions against the Yen.
The Euro also fell to $0.9998 against the dollar, its lowest level since December 2002, as the Euro zone’s energy supply crisis and economic woes continue to depress the Euro.
How Does a Strong USD Affect Indian Markets?
Though the Indian Rupee is not included in the basket of currencies in the U.S. Dollar index, any change in it has an impact on the Rupee too.
The foreign fund flow into Indian equities highly depends on the appreciation or depreciation of the Rupee against the Greenback.
The change in the U.S. Dollar also impacts the profitability of domestic businesses which either earn a large portion of their revenues in Dollars or import key raw materials.
The commodities and U.S. Dollar-denominated company debt are also impacted.
When the U.S. dollar rises against the rupee, the foreign institutional investors (FII) and foreign portfolio investors (FPI) get inferior returns on their dollar investments and vice-versa.
Stronger U.S. Dollar & Weaker Rupees Lead To FII Outflows
In spite of the Nifty rallying around 1,400 points in the last six weeks as domestic investors enjoyed bottom-fishing in troubled waters, foreign investors remain obscure in the Indian Market.
FIIs have sold ₹4.35 lakh crores over the last 16 months in the cash market segment, hurting the Indian market. In 2008 during the global financial crisis, FII had sold ₹1.31 lakh crores in 17 months.
This tells the intensity and amount are much higher in comparison to 2008. Over the past decades, we have seen the Indian Rupee (₹) value versus the U.S. Dollar and the Nifty moving in tandem on many occasions.
In the case of 2008 when the Indian Rupee went from ₹42 per U.S. Dollar to ₹50 per U.S. dollar, the Nifty fell vertically.
Then again in 2013 when the U.S. Fed first hinted at a bond tapering program, the Indian Rupee crashed from a level of ₹53 per U.S. dollar to around ₹68 per U.S. Dollar in a span of a few days. During that period also noticeable sharp correction in Nifty was seen.
The same phenomenon is repairing in recent times when the Indian rupee moved from ₹72 to ₹80 per U.S. Dollar mark and in response, the Nifty has corrected more than 15% from its peak.
What to Expect in Coming Months?
Commodity prices have corrected sharply in the recent past, and crude also has fallen below the $100 mark. US 10-year bond yield has stabilized at 2.7% from 3.5%, which indicates the market has discounted future fed rate hikes and inflation fear is fading.
This may shift Fed’s focus from inflation worries to recession. They may take a U-turn from liquidity tightening to loose monetary policy to support growth.
If we check the dollar Index chart, it is visible that the dollar index faced some selling pressure near its key resistance level of 110 and now trading near the 106 mark.
Falling commodity prices, bond yields, and the recent market correction in the Nifty and 16-month-long selling spree- All pointing in only one direction that FII selling is in the last phase and may get exhausted sooner than later.