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Understanding global events like Brexit Fed policy and its impact on currencies
With the advent of globalization and opening up of the economy, the impact and influence of global factors over the domestic markets have increased. Investors have become much more aware with surroundings amid the global events. Although the impact of global events on the company varies from case to case, there is definitely an impact on the investor sentiments which ultimately has an impact on the markets in the near term.
So, lets understand how does few of the major global events impacted the currencies in the past.
First is the Fed Rate How does a fed rate hike impact the INR? A rate hike in the US will lead to a stronger dollar and a weaker rupee, which will lower investment returns for foreign investors and prompt them to sell. Why does it happen? When the fed raises the interest rates, the investors looking for returns tend to sell assets denominated in foreign currencies and buy dollar-denominated assets as the spread over the US benchmark bond is much more attractive.
So, in order to buy dollar denominated assets, they exchange other currencies for dollars. The increased demand of dollar in exchange over other currencies increases the dollar exchange rate.
How does high dollar impact the Indian currency? The Indian currency is expressed in terms of another country’s currency, usually the US dollars as India’s majority of the foreign trade and foreign debt is USD denominated. So, any change in the rate of US dollars has a proportionate impact on the USD/INR exchange rate. Thus, the INR has a negative correlation to the USD,which means that when the USD becomes stronger due to any factor, the INR tends to depreciate and it works vice versa.
Next is BREXIT: Now let’s understand that how the Brexit impacts the currencies? Brexit or the Britain’s decision to exit European Union (EU) has been a big event for the currency markets. It had added a lot of volatility to an already uncertain global environment. The currency traders do not like volatility at all. So, the BREXIT was a big turndown for the ones trading the GBP/USD. Following the decision of BREXIT, the Great Britain Pound (GBP) had weakened almost ~10% over a passage of few days. How did the GBP weaken as against USD? The UK used to get trading privileges when it was within the EU. But following the BREXIT decision, the economic activity of UK would slow down due to loss of such trading privileges.
This results in lower investments into the economy and lower growth. What is the impact on GBP? Thus, lower growth will force the central bank of the country to lower interest rates of the country, which follows the same principle as above. Lower interest rates and uncertainty in the UK markets will lead to investors exchanging the GBP for USD. This will thus depreciate the GBP per USD. So, what about the INR? A stronger USD would eventually depreciate the value of INR (due to negative correlation). This would be triggered by the investors who would be shifting to the safe havens (USD) from the emerging markets (INR) due to the increased volatility in the global markets and political imbalance.
Before analysing the impact on any currency, we just need to understand that how will the particular situation impact the FII investors of the country. Post which we can analyse the impact of the event on the domestic currency also.