Rupee gains strength, dollar weakens as Fed takes a pause; traders eye Fed Chair’s testimony

Rupee gains strength, dollar weakens as Fed takes a pause; traders eye Fed Chair’s testimony

By Gaurang Somaiya

Rupee strengthened after consolidating in a narrow range for the last few weeks ahead of the important FOMC policy statement that was released earlier this week. On the domestic front, trade balance number was released and that too triggered volatility in the short term. Apart from this, inflation numbers from the US and India were released that set the tone for rupee appreciation during the week.

Dollar weakened against its major crosses after inflation in the US grew at a much slower pace than expected. Inflation in the US rose 4% in May compared to a 4.9% rise in the previous month. In line with expectation, the US Federal Reserve decided to keep rates on hold for the first time after 10 straight increases since March 2022. The Fed Chairman in his commentary added that it’s time now for the Fed to assess additional information and its implications for monetary policy. Although median estimates from its members indicate a 5.6% final rate. The dot plot suggests a couple of smaller rate hikes in the year cannot be ruled out and this hawkish pause by the Fed suggests that the US economy could weaken going ahead.

Move in the major crosses was driven by weakness in the dollar and after the ECB policy statement was released. The central bank decided to raise rates by 25 bps, the highest level in 22 years and left the possibility for more hikes. The ECB decisions were underpinned by fresh quarterly projections suggesting inflation will moderate more slowly than previously envisaged, to 2.2% in 2025, which is still above target but down from current levels of about three times the goal.

Currency outlook for this week

This week, focus will be on the Fed Chairman’s testimony, wherein any hawkish comment is likely to support the dollar that has been under pressure in the last couple of weeks. On the data front, from the US, housing and preliminary manufacturing and services PMI numbers will be important to watch and weaker-than-expected data could extend weakness in the greenback. Broadly, we expect that the dollar could continue to remain under pressure. After the ECB policy statement, the Bank of England’s policy meeting will be in focus wherein the central bank is expected to raise rates by 25bps and maintain a hawkish stance and that could lead to further gains for the pound. From the EZ and the UK, preliminary manufacturing and services PMI number will also be released and that could trigger volatility at the end of the week.

(Gaurang Somaiya, Forex & Bullion Analyst, Motilal Oswal Financial Services. Views expressed are author’s own. Please consult your financial advisor before investing.)