A currency war on the way? Donald Trump, Mario Draghi, US dollar in focus - Indian rupee to benefit if US Fed cuts rates further

While we were busy wondering how far the US- China trade war could go, there is a new battle emerging and this one is most likely to impact forex market. In a recent move, US President Donald Trump has accused the European Central Bank of manipulating the euro. Experts have started to indicate that US Federal Reserve may lead to monetary easing by making more cuts in interest rates in order to strengthen the dollar against other currencies. In short, a currency war is on the way, and devaluation of the dollar index seems a possible reality ahead. But where does it leaves the Indian rupee? Firstly, the Indian rupee has been appreciating against the US dollar at interbank forex market.  

On Wednesday, the domestic currency opened strong at  69.57 per dollar, and further gained to 69.49. While the dollar is expected to be the eye candy of currency war ahead, surprisingly the Indian rupee seems to be well placed for a Fed rate cut. In fact, if US central bank decides for further cuts in policy rate which is a highly likely expectation of markets and investors, it will turn out to be positive for Indian rupee. Here’s how! 

European Central Bank’s further rate cut indication! 

On Tuesday, Maria Draghi, President of European Central Bank (ECB) said, “With underlying inflation already weakening, inflation expectations began to be affected. As the scope for further interest rate cuts was now limited, it became increasingly clear that our reaction function needed to evolve to address these new challenges.”

Going forward, Draghi added that, “We remain able to enhance our forward guidance by adjusting its bias and its conditionality to account for variations in the adjustment path of inflation. This applies to all instruments of our monetary policy stance.”

With that,  Draghi hints for further cuts in policy interest rates and mitigating measures to contain, by saying “ any side effects remain part of our tools.”

Talking about ECB move, Anindya Banerjee analyst at Kotak Institutional Equities said, “ First came from ECB chief Draghi. European Central Bank chief said that the ECB will need to ease policy again, possibly through new rate cuts or asset purchases, if inflation does not head back to its target. This lead to a scamble for long dated bonds and as a result, the German government bond yields hit record lows deep in negative territory and French 10-year yields turned negative for the first time on Tuesday. Risk assets like equity, commodity and credit zoomed higher.”

On that day, even Indian rupee appreciated  against the Euro and USD too.

Then came the US President Donald Trump punch!

Right after Draghi indicated for further rate cuts, US President Donald Trump took to his twitter saying, “Mario Draghi just announced more stimulus could come, which immediately dropped the Euro against the Dollar, making it unfairly easier for them to compete against the USA.”

This led  USDINR touch a low of 69.50 on the NDF, on spot reference on Tuesday.

How does US Fed rate cut will work in favor of Rupee.

According to Banerjee, US President when he criticised both the ECB chief as well as the Fed chair. Trump said that ECB has been pursuing policies that keeps the Euro weaker against Dollar, hurting US economy. This would not be tolerated. He said that Fed needs to lower rates. This too boosted the risk assets further. It is clear that US administration is now turning attention also towards the global currency war. 

In Banerjee’s view,  major central banks around the world are fearing that if US begins the phase of easing monetary policy it lead to significantly strengthening of their own currencies against USD, thereby triggering competitive devaluation. It could be this fear which is prompting them to front run the Fed and either lower rates or talk about fresh round easing.

Going forward, US may finally look at weakening the US Dollar. If the Fed policy is unable to do that, they can either compel the partner nations to sign another Plaza Accord and appreciate their currencies against USD. In this, Banerjee says, “ China may not agree and not even Eurozone.” Adding, the analyst says, “If they do not, they can look at the next option of asking the US central bank to intervene in the foreign exchange market and weaken the US Dollar.”

Even though such a step may appear unthinkable now but, Banerjee says,  “if you consider how Trump administration has gone ahead in the trade war, the low probability outcome appears to be quite likely.”

Rupee’s take on currency war! 

“If US Fed hints at lowering rates, as the market expects, then it would be positive news for Rupee. With ECB talking about easing, and now Fed, money flow to India can increase significantly, compelling RBI to mop up Dollars,” said Banerjee.