What are the key factors which contribute in the value fo dollar. Is it its weak governance regime of dollar market players, or other fundamentals like CPI inflation rate, discount rate, international market changes, international energy prices adjustment or demand of dollar in local market than its supply. The role of IMF program is also cardinal in its assessment of dollar value.
There is a general misconception that the IMF loves asserting adverse conditions and that they would be against a rate cut. If there is a sound reasoning and if data supports that, there is no reason to keep interest rates elevated.
The other factor is the general price level or the inflation. In the present scenario, although headline inflation appears inflated, it has sharply decreased, with Mar 24 inflation expected to be around 20%, and core inflation also expected to subside to 16%. Real interest rate will be positive on a forward-looking basis.
The growth and unemployment is the major factor hindering to meet the basic needs of common man. This can be addressed by cutting the discount rate and bring megha investment in various sectors.
Is this the right time to cut rates?
We project SBP to cut rates in the upcoming MPS by 100 bps. The caretaker government has long been calling for an interest rate cut at the first opportunity and this appears to be that. Demand is significantly down, CAD is well contained, Rupee is on the rise, political environment is much better and the business community is being stretched by substantially higher financing costs. International oil prices and dollar value is stay stable then the general prices level is expected to fall down.
600 bps rate cut this year
Analysts project inflation to come down to around 16% by the end of the calendar year and expect a 600 bps cut in policy rate between the 7 MPC meetings expected this year. This can create a much better ground for investors to create jobs.
How low can USDPKR go?
With Rupee consolidating, everyone is bracing for USDPKR to go down further, citing better Ramadan inflows and anticipating a successful third review of IMF.
Although it may appear that the direction is down, we expect SBP to buy the excess dollar liquidity to keep the market stable. FX Reserves have already increased by a significant $130mn. The line in the sand for USDPKR is around 277/$, which marks the recent low of Oct 23. We expect support because there is very little to gain by a stronger Rupee and much to loose by way of lost exports and subsidised imports, where as current REER also denotes a marginally over valued Rupee. It must be kept in mind that exporters are already being hurt by steep rise in energy prices, high cotton prices and multiyear high interest rate costs.
Swap Premiums
Swap premiums have retreated from their recent highs and reflect 1. market’s view of declining interest rates 2. Forward selling interest from exporters & 3. Comparatively lesser dollar liquidity in the interbank market. With upcoming bond repayment of $1bn next month, analysts expect that the swaps to go down further, though gradually.
Rupee Outlook
We expect Rupee to remain range-bound if there are no surprises on the IMF front. If there is a rate cut, it might wobble but then fall back in line. If there is no rate cut, we might see it test the 278 level.
US inflation rises to 3.2%
The US inflation (both CPI & Core) rate crept higher in February, which triggered a quick rally in the dollar and a sell-off in government bonds. The increase in inflation was mainly due to energy costs, such as gasoline, falling less than expected.
The US dollar responded to the inflation report with sharp swings against the major currencies. The markets have lowered rate cut expectations, as the Fed will be less inclined to lower rates if inflation is moving higher. The Fed is virtually guaranteed to pause at the March meeting and the probability of a June cut has fallen to 66%, compared to 90% just one month ago.
Assets on a surge
The spectacular bull market that resumed in mid-October has continued into the first 9-weeks of 2024. Bitcoin has surged past the $70k level. Copper and gold prices have had a sharp run of late, while WTI crude oil has surpassed the $80 level. Rising commodity prices have helped fuel a rally in energy stocks and miners.
