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Forex pairs in this Article » GOLD, USDOLLAR
The Indian Rupee has plummeted by over 10 percent relative to the USD since USDINR’s April 30 low of $53.13, and Gold prices have seen similar declines following yesterday’s US Federal Open Market Committee meeting. Why?

India is also one of the world’s largest consumers of gold, and the INR has historically been negatively correlated to gold prices. Indeed, weaker gold prices should in theory favor Indian Rupee strength as domestic consumers pay less for gold from abroad—thereby improving the country’s trade balance.

The chart below shows the relationship; if Gold prices rise, the Indian Rupee should fall (USDINR rally). That worked reasonably well until recently.

USDINR Exchange Rate versus Price of Gold Chart

forex_indian_rupee_tumbles_as_gold_prices_plummet_-_why_body_Picture_3.png, Indian Rupee Tumbles (USDINR Surges) as Gold Plummets - Why?The Indian government increased its import tax on gold, which should further decrease Indian purchases of gold. All these factors combine to put downward pressure on the USDINR, but why hasn’t it fallen?

There are several factors influencing the sell-off in both the rupee and gold. One factor is the Fed’s signal that it will taper QE earlier than expected, which causes strong financial market risk aversion. Emerging Market currencies are largely selling off on the news and India is no exception. The MSCI Emerging Markets Index is off a substantial 11 percent from its May peak—a remarkable 65 percent annualized rate of declines.

10YR US Treasury yields now approach 2.415% at the time of writing. At the same time, the spread between 10YR Indian government bonds and 10YR US treasuries has tumbled below 5.0 percentage points for the first time since May 2011. This also means that Indian bonds are now less attractive compared to US bonds and puts upward pressure on the USDINR exchange rate.

It remains to be seen how the Indian government and the Reserve Bank of India will direct future policy amidst current economic conditions. Concurrently, gold’s price action should be interesting to watch as the asset continues its rapid decline.

The Indian Rupee isn’t falling because gold prices have tumbled, but further commodity market sell-offs could push the USDINR to fresh highs.

--- Written by David Rodriguez, Quantitative Strategist and Kevin Jin, DailyFX Research

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