The US dollar has gained against most currencies recently and the dollar index is trading near multi-month highs. Concerns over the second wave of coronavirus infections globally and a bleak economic outlook for the US and Europe is prompting investors to seek refuge in the greenback, say market observers.
Analysts believe the dollar is likely to gain further due to the US Federal Reserve’s warnings that the US economy needs more fiscal stimulus. That is because the US economy is considered as a barometer of the health of the global economy. If the world's largest economy is expected to do poorly, investors fear other economies are likely to do worse, and so reduce exposure to riskier assets like emerging market equities and bonds and most likely redeploy that money in the US Treasury bills, causing the dollar to firm up.
The rising dollar also impacts various asset classes in India. Here's all you need to know about the dollar index and its impact on Indian markets.
What is US dollar index?
The US dollar index is used to measure the value of US dollar against a basket of six major worth currencies of the US’ significant trading partners. These currencies are Euro, Swiss Franc, Japanese Yen, Canadian dollar, British pound, and Swedish Krona. The value of the index an indication of the dollar’s value in global markets. A higher reading means a stronger dollar.
The dollar index was established in 1973 after the Bretton Woods Agreement dissolved with a base of 100.
The Euro makes almost 57.6 percent of the basket and is the largest component of the index followed by Japanese Yen with 13.6 percent. GB Pound has 11.9 percent weightage, Canadian dollar 9.1 percent, Swedish Krona 4.2 percent and Swiss Franc has 3.6 percent weightage.
Why is dollar index rising?
Recently, the dollar index hit its two-month peak level above 94.50 and analysts expect the greenback to rise further above 95.00 amid recent global developments.
In times of global economic uncertainty, the safe-haven status of US dollar has encouraged investors to park their money in the greenback.
Concerns over the economic impact of the second wave of COVID-19 infection cases, and the consequent impact on economic growth is making investors jittery.
“Previously, traders were betting on faster European economic growth compared to the US but with the rapid increase of the coronavirus cases in the Europe it seems that bets for more dollar strength are increasing,” said Rahul Gupta, Head Of Research - Currency - Emkay Global Financial Services.
Supporting the dollar further is the rising uncertainty over extra stimulus from the US Federal Reserve.
Meanwhile, analysts expect newsflow relating to US Presidential elections to keep the dollar volatile. The market’s focus will be on next week’s first Presidential debate of the 2020 election. Vice President and Democratic nominee Joe Biden and President Donald Trump will square off on September 29.
The US Federal Reserve is expected to underwrite Treasury issuance, capping any significant bond sell-off and the dollar, irrespective of who wins the White House on November 3.
According to a Société Générale report, a win for President Trump would trigger a short-term dollar bounce, as fears of further trade conflict grow.
However, if Biden wins the White House the dollar is expected to fall sooner, and potentially further if the Democrats gain control of both the House/Senate in Congress.
An extended period of uncertainty, due to either delay in announcing a winner, or worse still, a contested election, would be bad for risk assets, and therefore, would not be dollar negative, the report said.
“The dollar index has gained amid economic and political developments around the world. The rising infection cases in Europe and fears of another lockdowns are supporting safe-haven demand for the dollar,” said Amit Sajeja, Commodities & Currencies at Motilal Oswal.
Sajeja expects dollar index to test 95-95.50 levels going ahead.
How does it affect Indian markets?
The Indian rupee (INR) is not included in the basket of currencies in the dollar index However, any change in the index has an impact on the rupee as well. The appreciation or depreciation of rupee against the dollar impacts the foreign fund flow into Indian equities. The strength and weaknesses in dollar also affects the profitability of Indian companies which either earn a large chunk of their revenues in dollars, or import key raw material. The commodities and dollar-denominated corporate debt are also impacted.
Where dollar index weakens, the rupee rises against the USD and vice-versa. When USD falls against the rupee, the foreign institutional investors (FII) and foreign portfolios investors (FPI) get better returns on their dollar investments.
Among companies, the exporters tend to benefit from the rising USD and depreciating INR. The IT and Pharma companies in India are major exporters of goods and services and receive most of their revenue in USD terms.
India is a major importer of crude oil. If the dollar rises, the crude oil gets costlier. It will affect the profitability of the oil importers and Indian refineries such as IOC, HPCL and BPCL.
