How To Track The Greenback

***(this was an article written by me and my colleague Saswata Das some time back for ANMI yearly magazine - some data points have changed, but the underlying factors have not. Relevant for all those who have an interest in currency derivatives markets and even those who are not, but have heard terms about currency swaps during BRICS summit or have heard the dollar is flying away or have heard about the rising crude prices. I will present in 4 parts - first part today)***



The past few weeks have been one of intense turmoil in the currency market. The US Dollar spot rate has seen a minimum of 43.85 (end-July) and a maximum of 49.89 (mid-September) INR, a swing of close to 14 percent in a span of less than 3 months. This has confounded the market participants including the traders, retail clients, the investors and the economists alike. This swing is all the more spectacular given the fact that the US itself was in the throes of a debt crisis itself in July, which had led to a literal gold-rush reporting a huge surge in the price of the yellow metal.

However, since then, fears of a global recession, led by fears of default in South-European economies and downgrades by rating agencies, has led to increased confidence in the US Dollar. But does this not necessarily mean a weak Euro. The Euro / USDINR ratio has been down since the highs of May and June, but it was at its lowest this year in January. What does all this mean? To an ordinary investor or even a seasoned trade, all these might be very confusing. The fact that unlike equities or even commodities, there is a vast array of factors that causes these swings. A 24-hour market that affects economies, the currency market can seem a bit intimidating. However, a closer look at the currency derivatives market will indicate that there are some factors that affect the prices more than others. Here we will have a look at those factors, mostly from an Indian perspective.

USD/INR & the Indian Stock Market

The Indian Rupee has always been critically poised against the US Dollar. Any significant event in any corner of the world sways the currency market in a big way. Be it the US Debt Default Drama or the much talked about Euro Zone turmoil or the highly melodramatic downgrading exercises made by the credit rating agencies, occurrence of all or any of these events can affect the highly leveraged currency trading business.

But how does a trader in capital market who follows Nifty or SENSEX, the broad market indices stands to gain from this. Let us analyze effect of USD v/s INR on Nifty and USD as an instrument. If we appreciate the long term movements of USD v/s INR marked with important Nifty Levels. It can be seen that the strengthening of Rupee leads to stronger Indian Markets whereas Strengthening of Dollar correlates with Nifty bottoms.

This correlation can be closely observed in one year chart where important peaks and troughs of Nifty are almost inversely correlated with the USD-INR relationship. Any strength in Rupee accompanies an influx of FII money and hence a rally in Nifty, also the opposite will hold good by downward trend continuing in case of bounce by USD from there.

The underlying reason is the fact that the equity markets to a large extent is controlled by Foreign Institutional Investors and by that logic more FIIs coming in to invest in India shoots the Nifty up and the supply of USD in the economy simultaneously causing an indigenous fall in the price of USD. Hence when you are bullish on Nifty, be bearish on USD & vice versa. A trader can always use his expertise in the field of Nifty trading and can benefit immensely while trading currency pairs in general and USD in particular.

So in all we gather that the simplest of correlations that exist in the market is of Nifty and USD.