By Mihika Sharma 

The Indian rupee has slightly strengthened over the past trading sessions closing at 83.91 on August 26 compared to 83.95 about a week ago. 

A weaker dollar is offering some support to the rupee, however, dollar demand from importers and foreign portfolio outflows from Indian stocks (USD 1.5 billion so far in August, as on August 26) have limited rupee’s gains.

As a result, the rupee has only strengthened by 0.1% over the past week. In comparison, other Asian currencies have seen more significant gains over the same period – the Chinese yuan has appreciated by 0.6%, the South Korean won by 1.6%, the Indonesian rupiah by 1.7%, and both the Philippine peso and the Thai baht by 1.9%. 

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The dollar index is near an eight-month low at around 100.9, down from about 102 a week earlier, due to dovish signals from the Fed. In his Jackson Hole speech, Fed Chair Powell indicated that it is time for the Fed to begin rate cuts, as the upside risks to inflation have diminished while the downside risks to employment have increased.  

Powell noted that for the last three years the Fed’s primary focus has been on reducing inflation. The restrictive monetary policy stance has eased inflationary pressures, and his confidence has grown that inflation is moving back towards the 2% target sustainably. This progress allows the Fed to now focus on the other side of its dual mandate, which is ensuring maximum employment.  

He noted that the recent rise in the unemployment rate, nearly a full percentage point over the past year, is not due to elevated layoffs typically seen during economic downturns. 

Instead, he noted that the US economy continues to grow at a solid pace, and the rise in unemployment is due to a significant increase in the labor supply and a normalization in the pace of hiring. 

Despite this, he pointed out that the labor market has cooled considerably, with job gains slowing and the ratio of vacancies to unemployment returning to pre-pandemic levels. 

He stressed that the Fed does not seek or welcome further cooling in labor market conditions. Consequently, Powell mentioned it will be appropriate to reduce the policy restraint to support the labor market, given the notable progress on inflation. However, he did not commit to the timing and pace of rate cuts and emphasised these decisions will be dependent on the incoming data.

Separately, the minutes of the Fed’s July meeting, released last week, indicated that a vast majority of policymakers believe it would be appropriate to ease policy next month. 

This along with the significant downward revisions made to the US nonfarm payrolls signals that the Fed will cut rates in September.  The market is currently pricing in a 72% chance of a 25bps Fed rate cut in September. 

Investors are now awaiting the US PCE inflation data, the Fed’s preferred inflation measure, due this Friday, and the August job market report next week, which will play a critical role in shaping the market expectations about the size of Fed rate cuts. 

We expect the rupee to trade between 83.60 and 84.10 in the near term.  While the approaching Fed rate cuts may provide support, rising oil prices could put some pressure. 

Brent crude oil has crossed USD 80 per barrel, up from around USD 76 per barrel a week ago, driven by hopes of Fed rate cuts and rising Middle East tensions. However, inflows from the rebalancing of MSCI equity indexes may offer some support to the rupee. We expect the RBI to intervene on both sides, as needed, to contain any rupee volatility.

(About The Author: Mihika Sharma, Associate Economist at CareEdge Ratings)

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