Globally economic data has been mixed with mixture of hits and misses in the economic releases. In Asia, Japanese retail sales, household spending and industrial production data for the month of June showed meaningful deceleration, an after effect of sales tax hike and the income squeeze from a rising prices in the economy. We have to understand that if unlimited debasement of money can become the recipe for growth, then by now all the major economic failures should have been glorious success stories in the books of economics.
Chinese PMI was mixed with private July manufacturing PMI estimates coming below expectation but official estimates were a beat. However, both being above the 50 level, indicated ongoing expansion in manufacturing sector in China. In fact over the last few weeks, when the global equity markets have gone into phase of down ward correction, Chinese equities have sprung to life. We could be seeing a shift of money towards China, expecting the mini stimulus measures unveiled by the government over the last few quarters to pump up the economic growth in the nation. At the same time there is hope that Chinese government could liberalise capital flows into the onshore financial markets. However, Chinese economy still remains saddled with excessive debt fulled investments and the immediate hope of economic recovery can occur only if the major world economies show sustained robust growth. Global growth remains stable but far lower than hay days of 2003-07 or 2009-10. At the same time, trade growth relative to world economic growth has also declined, reflecting a shrinking pie of global export market, which has also become too competitive. In such a scenario, the arsenal of an exporting nation remains the strategy of keeping its currency weak and providing support to its exporters. Chinese exporters have had a rough time over the last couple of years, as QE lead hot money flow as propped up the Yuan, at a time, when other Asian, EM and European competitors are following an unofficial competitive FX devaluation policy.
From Europe, consumer price inflation data continued to slide lower, giving discomfort to the European Central Bank. ECB does not want to see asset deflation or debt deflation in Eurozone, where lenders see falling collateral values and rising risk of default. Though it can be argued we have already seen or are still seeing some version of that in several peripheral countries in the currency Union. A debt deflation at a time, when leverage in the financial system remains high, can increase solvency risks. Therefore, in order to avoid that all the central bank does is to pump up the money available in the banking system and then uses various means to incentivise lending, However, credit off take and disbursement can not be fully influenced by a central bank and therefore, at times it becomes akin to pushing on a string.
In Europe, PMI survey of the peripheral businesses failed to beat estimates but in Germany, retail sales were upbeat. In Spain, Q2 GDP posted a growth of 0.6%, beating estimates. In US, Q2 GDP was much better than expected, printing at 4%. Growth was broad based with inventory accumulation and business investments contributing strongly. However, US regional economic survey like the Chicago PMI was a shocker. The ISM manufacturing survey in US did fairly well. US economy added 209K jobs in July, a six straight months of 200+ jobs growth. Consumer sentiment was upbeat in US and the wage growth showed signs of improvement.
US Fed has been conducting a very inflationary monetary policy over the last 6 years and the effect of this enormous inflation has been largely confined more to the global asset market and domestic housing market. Over the last few years, price levels of goods and services have started to tick higher, though wage growth has been anemic. We have to understand that labour wages are a lagging indicator and it can never be a true measure of inflation in the economy. One can track money supply growth to understand inflation or debasement of currency, whose effect is of a general increase in price levels from asset prices to prices of goods and services in the economy. Therefore, we believe effect of inflation, will felt in the future. The question therefore, remains can US Fed continue to pursue the extraordinary accommodation it is currently doing. This uncertainty and also the stoppage of QE3 can cause a shift in carry trade away from the US Dollar into ongoing debasing currency like Euro and Yen. This handover of the liquidity baton can create turmoil and volatility in the financial markets. Hence, over the next 3/4 months, can see volatility rise and so the US Dollar. However, the strength of the US Dollar might be more of a slow and steady kind than a sharp and quick one. Though latter can occur incase an economic and/or geo-political crises emerges.
Over the near term, keep an eye on the US economic data, as an upbeat economy and higher inflation metric can fan expectation of a reversal in US Fed policy, which will be supportive for the US Dollar, Indian Rupee can trade within a range of 60;40/60 and 61;25/50 on spot. RBI monetary policy will be the key focus, where a status quo is expected.
By Anindya Banerjee, analyst, Kotak Securities