Graphic: Mint
Graphic: Mint

Oscar Wilde, the fall of the rupee and the nervous stock markets

The increased probability of Fed rate hikes coupled with a strong dollar would add to the pain for already battered emerging market currencies

Oscar Wilde is being vindicated. In his play The Importance of Being Earnest, Miss Prism tells her student, “Cecily, you will read your Political Economy in my absence. The chapter on the Fall of the Rupee you may omit. It is somewhat too sensational." The Indian currency seems to be exerting itself to proving Wilde right, by plumbing new depths almost every day.

On Monday, the rupee hit a fresh record low against the US dollar, on the usual worries about the country’s widening current account deficit, trade wars, a strong dollar et al. Bond yields hardened further, spooked by worry that the central bank may have to hike its policy rate to defend the Indian currency. The prospect of higher interest rates and high oil prices dragged down the stock market. As a result, the Nifty ended the day’s session down 151 points at 11,438 and the Sensex sank more than 465 points to close at 37,922.

On a year-to-date basis, the rupee has now lost more than 13% against the dollar and is among the worst performing emerging market currencies.

On Monday, there were additional reasons for the continuing fall in the rupee. One of them was proof of a widening current account deficit for the June quarter. A second reason, albeit one that affects all emerging markets, was the latest US jobs report.

It showed that while American unemployment continued to remain at an 18-year low in August, workers’ pay saw the fastest rate of increase since the end of the Great Recession. Earlier, data had shown that consumer spending, which accounts for two-thirds of the US economy, remained solid in July. As a result, core PCE (personal consumption expenditure) inflation, the yardstick the Federal Reserve keeps a beady eye on, went up to 2%, which is the US central bank’s target rate.

Growth in the US economy has been very strong, although there have been some recent signs of deceleration. The August PMI (Purchasing Managers’ Index) survey on the US economy said, “Companies continued to report strong pricing power, underscoring the on-going buoyancy of domestic demand in particular. Average prices charged for goods and services rose at a rate only slightly below July’s nine-year survey record high." Strong pricing power will result in further inflationary pressures.

Strong growth and rising inflation raises the prospect of faster rate hikes by the Fed. CME’s FedWatch tool, a widely-used gauge of the Federal Open Market Committee’s actions, showed that the probability of rate hikes by the US central bank in a year from now has increased sharply (see chart). The chart shows that there’s now a 36.7% probability that the Fed Funds rate a year from now will be a 100 basis points higher than what it is now.

The robust jobs data gives a further boost to the dollar, while the yield on the benchmark US 10-year Treasury note inched closer to the 3% mark. The increased probability of interest rate hikes coupled with a strong greenback would add to the pain for already battered emerging market currencies.

As for the rupee, apart from external factors, the deteriorating domestic macroeconomic environment— especially rising crude oil prices and domestic political uncertainty— would weigh on the currency in the near term.