Markets are in a mood for whipsaw over the month of October. Yes, we got some sharp upswings in Dollar, but barring in GBP, where I have been expecting weaker prices since Brexit, there are no trend-creating triggers till the US elections. I feel the same is the case for other financial assets as well. Global equities remain well supported, as major indices, in spite of their recent pullback, have enough technical cushion to keep the primary uptrend going.
The mother ship, US Stock market, like the US Dollar remains resilient as asset allocators see US as a dynamic economy full of potential, the Fed still wants to hike and Washington is likely to loosen the purse strings after the election. Even if just one of growth, rates or politics improves, there can be plenty of upside in the US Dollar.
In emerging market space, China remains a spot of vulnerability. Yuan has traded at the lowest level since 2010 at 6.72/6.73 against the US Dollar. Economic data released over the last week from China was a mixed bag, as exports slumped by double digit and imports too showed weakness but inflation has started to pick up.
However, I was a bit surprised as to how there was too much of unnecessary importance given to the fact that producer prices index, which is a proxy for whole sale level inflation, has now inched above zero. It is amusing how one single economic data can be blown out of proportion nowadays to sell “China is back” story. It seems they refuse to get the obvious, that Chinese economy cannot be even a shadow of its past as it remains bloated by over leverage, mal-investment, poor economics, inverted balance sheets and dangerously unbalanced growth engine. The rise in PPI from near negative 7% to now positive 0.1% from December 2015 to September 2016 is driven by near 60% surge in crude oil prices over the same period and government stimulus driven surge in house prices. A sharp bounce back in oil prices have enabled spot inflation measures to move up sharply.
Remember oil, due to its importance in the economy and commerce, affects the cost curve of every commodity. Therefore, when oil prices move by a large degree it creates a collateral impact on prices of other commodities. They together with higher cost of transportation triggers a broad based rise in price level in the country. Thanks to the surge in oil prices, globally long term yields, which is less anchored to current zero rates or negative rates of central banks, have also inched higher.
However, this rise is driven not by upward shift in long term inflation expectation or growth expectation but by current rise in oil prices. Therefore, as long as oil prices inch upwards, there will be an upward rise in inflation measures and long term yields globally. However, I believe oil recent surge appears more like a cyclical bull run within a secular bear market, where range of prices have moved lower and hence, the rise in bond yields would not be a permanent phenomenon, unless there is a significant fiscal push from the developed world governments.
Let me take you through an interesting economic phenomenon playing out in India. Back in 2013/14, I was fortunate enough to spot a major trend change in Indian economy. It was the beginning of the structural outperformance of urban India over non-urban parts of the country. I had named the play as “Long India and Short Bharat”. It is more a relative bet and not an absolute one. Between 2000 and 2012, non-urban India benefitted from an interplay of super cycle in commodities, a significant up cycle in real estate prices, government spending on higher MSPs and rural focused programs to boost consumption and surging cash economy (black economy). In 2013/14 we highlighted the three forces that can adversely affect the above tailwinds for non-urban India:
1) Government of India (GoI) needs to augment its revenues to fund the inclusive growth model that Mr. Modi believes in. In absence of growth surge of 2000, government cannot depend on elusive tax buoyancy to fund the spending. It has realised the need to tax a larger share of unaccounted part of the Indian economy. The downside of such measures is that money flow to real estate and land would slowdown. With cycle extended and prices at loft levels and little demand on ground, real estate would enter a phase of pro longed downturn. We had pointed about such an eventuality 2/3 years back.
2) GoI does not have the funds to splurge on rural focused populist programs like the UPA government had. At the same time, NDA lead GoI is focused on better quality of fiscal expenditure, relying more on capital lead spending than revenue lead spending.
3) Commodity super cycle has come to an end. If history is any guide, the secular trends in commodities, up as well as down, last for a long time. With the world going through an economic rebalancing, which can take years to complete and US Dollar on an upswing, there is no sight of the ongoing secular downturn in commodities to end soon.
Before I conclude let me take you through the important events lined up for the upcoming week as well as the outlook on currencies as well rates. US Fed vice chairman Fischer speaks, which will be have impact on all major dollar pairs including Indian Rupee. At the same time, ECB lending survey and UK CPI will have impact on Euro and GBP pairs. Apart from Fischer there is a whole barrage of Fed speak next week, which will have some impact on rates and FX pairs. Chinese Q3 GDP will be out along with other economic data, which will be watched by EM pairs.
Post ECB monetary policy, the conference will be watched keenly for clues about possible extension of asset purchase program beyond March 2017. If ECB chief drops any hint of extension it will be negative for Euro. UK retail sales will be a market moving data for GBP, which remains on a path to more weakness. Indian Rupee is expected to strengthen against Euro, GBP and JPY but remain ranged between 66.40 and 67.00 on spot against the US Dollar. Indian 10 year bonds prices can find demand on weakness as a range of 6.75%-6.88/6.90% is expected.