Dollar Movements May Be Linked To
US Interest Rate Policy

The currency markets are led by the trajectory of US interest rates to a large extent. With inflation coming down and the US economy registering robust growth the likelihood of US interest rate policy getting into a tightening mode after three pauses can be ruled out. This has resulted in a kind of selling of the US unit, and the currency majors strengthened against the Dollar. This move may be a temporary phenomenon which may last another two to three weeks. But the basic trend may set in again after the retracement. The main reason for this is that the Fed has stated that rate action may be resorted to based on incoming data, and that it is too early to conclude that the US has come out of the policy tightening. This still leaves room open for further Fed action in future. The Fed has always been in readiness to sacrifice some growth for price stability though the GDP number reflects no sacrifice as such due to the rate hikes. But there are early signs of a slackness in the economy. These developments are actually reflected in the movements in the Dollar Index in the last three months. The Dollar Index which touched 106.80/107 levels early in Oct 23, moved down to 102.70 levels by end Nov,23, and the Index moved up to 104.10 mark just before the last FOMC meeting. Therefore, Dollar lost some ground and it recovered from the lows. After the FOMC statement the Index has moved down to 101.90 and may test the 101.30 and 99.80, in that order. During the same period we had seen the beginning of the conflict in Israel and this also helped the Dollar to revive its fortunes to a significant extent. In the immediate term, after the fall, there could be a Dollar revival but that may gradually wane as there is more clarity from the Fed on the future interest rate policy. Some revival in the foreign inflows recently has helped the Rupee stay more or less stable, the Rupee may weaken as we move into the first and the second quarter of the next calendar year unless RBI intervenes to supply Dollars to the markets which is quite possible with a forex reserves level of US$ 600 billion plus. While strong FII and FDI flows could counter this, the impact of trade on the currency levels, especially in a scenario of sagging exports. cannot be ruled out.

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