So, did the US Fed ‘chicken out’? We do not think so. However, they have definitely tried to play safe, and also like a ritual, did what they have done so many times since the Great Recession, downgrade their economic forecasts to a more realistic level. They are not alone in this, IMF and many of us – the buy/sell side community – is guilty of that too. Enough ink has already been spilled as to explain why the structural reset has confounded most observers but let me talk about another angle to economic forecasting. Economic forecasting is like driving through a mountainous stretch in a thick fog. The driver has a fair idea where the road leads to and where he wants to go. However, visibility is limited to a few meters and hence one has to be alert. The driver knows that he may have to alter course and make sudden evasive maneuvers, if the situation demands.
Economic forecasting should also be done and accepted in that light. Nothing is etched in stone. In fact, since 2009, the fog has been thicker than usual and weather has been erratic. There are enough forces at play to ensure that things remains like that, but to summarize, I would say, debt financed consumption and investment boom, that had got way to extended, reached its inflexion point and is now on a corrective course. Hence, too much supply and inadequate demand keeps haunting many global sectors, across most economies, from developing nations to developed nations. Time is the answer but time which is in short supply, especially for the quick fix policy framers and policy executers. Their impatience reminds me of the line from the famous poem from Robert Frost, “Stopping by Woods on a Snowy Evening”: “The woods are lovely, dark and deep, but I have promises to keep, and miles to go before I sleep, and miles to go before I sleep.”
Would the Fed hike in December or next year? It does not matter, as long as they do in the near future. The bigger question is what is the overall bias of their monetary policy and why did they refrain from committing to a timeline. I believe, US Fed sees the situation in Euro zone as fluid and serious. The game of thrones being played in Euro zone, a political theater, is both dangerous and dramatic. US Fed did not want to box themselves in a corner, by calling a timeline, and then see “Grexit” become a reality and markets turmoil. US Fed may have wanted to keep the flexibility on, so that, in case Euro zone finds another innovative way to kick the Greek can down the road, like they have done umpteen times over past six years, US Fed can bring the rate hike theme right back on table.
Another reality is that, US Fed is no longer writing any fresh cheques to finance the global asset boom. The result, though quite expected but has been very significant, one of the engines of the asset boom has already failed, the hard assets. The financial asset engine is still very much generating enough power but some kinks have started to appear at the margin. Bank of Japan and ECB have tried to provide a secondary support, and they have done a decent job, as without their support, probably we have had lost both the reflationary engines. However, the question remains, how long can the jumbo jet sail on just one engine?
There are reports of Chinese monetary and fiscal pump priming happening. We have already seen China embark on a ECB-like LTRO like mechanism, where they allowed banks to buy debt of regional governments to swap them for funds with the central bank. Now they have also allowed the regional governments to spend more by issuing more bonds, something the central leadership abstained from, in the name of rebalancing the economy. However, it seems the pain and reality of good behavior is becoming a too much a burden to bear. Hence, they may have resorted to their old ways of inflating the debt financed supply side over investment even more. If that is true, it can provide some life to hard assets, especially commodities and Chinese properties for a short time, but it comes with bigger medium to long term cost.
Back home in India, our external trade for the month of May, moderated further, not a very encouraging sign.
Sluggish exports growth momentum and renewed signs of weak domestic demand-led fall in imports aided the comfortable trade deficit print. In my last week’s column, I explained the causes behind the improvement in current account balance. The sharp contraction in core imports, ex-petroleum and ex-gold, is a sign of weak domestic economy. The core imports plunged by 3.5% in May, after rising 7.1% yy in April. However, capital goods imports remained stronger. Of late, the capital goods segment has been strong in IIP composite index as well. These indicate that the investment cycle has started to move, though the pace remains moderate. May trade deficit moderated to USD 10.4 bn from USD 11 bn in April. Exports contracted by 20.2% yoy. Even after excluding petroleum products and gems and jewelry, exports contracted around 8-9% in May.
In a positive development, monsoon has started well. Based on data available with IMD, till 19th June, out of 36 meteorological sub-divisions in the country, 16 have received excess rainfall, 7 have received normal rainfall, 9 have received deficient rainfall and 4 have received scanty rainfall. The next 30 days will be key for monsoon, as normal rains over the next 4 weeks, shall ensure a strong sowing of agricultural crops. A bumper harvest shall push prices of agricultural commodities lower and ensure food inflation does not become a problem. A lower inflation can bring about some more ease in the monetary policy rates over the coming quarters. However, remember, in case of bumper crop, with global commodity prices on a down swing, we can see rural India get into income stress later during the year. However, for urban India, it is a gain and so for Indian bonds.
Over the next week, traders will wait and see, whether RBI hikes the government debt limit for FIIs, as expected. At the same time, Greece has become a political battlefield between Germany and Southerners. A messy Grexit, can be negative for risky assets. At the same time, an interim reprieve can bring about a relief rally in stocks and EM currencies and Euro as well. Indian Rupee to remain in a range of 63.00/63.30 and 64.00 over the near term.
By Anindya Banerjee, analyst, Kotak Securities
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