What a week for the US Dollar bulls. It was hard to find a currency which stood up against the relentless surge in the US Dollar. Indian Rupee, which has been an outperformer amongst the non-dollar currencies failed to hold its fort against the almighty Greenback. Rupee weakened from 61.90 to all the way down to 63.00 handle on spot. However, the same Rupee gained ground against both Euro as well as Pound, just goes on to show, how much those two currencies weakened against the US Dollar. Indian macro data did not carry much surprise. Globally, traders were not really deterred by the slew of weaker than expected macro data from US, all being brushed under the carpet in the name of “very cold winter effect”.
Euro zone’s central banks began their asset purchase program, under which it is estimated that ECB would be purchasing around 3 billion euros of government and private debt a day, with an overall target of 60 billion euros for a month. President Mario Draghi said purchases won’t be made of securities whose yield is below the central banks minus 0.2 percent deposit rate. As bonds rally during quantitative easing, more debt could be pushed out of eligibility as yields on shorter-term debt is driven below zero. Thanks to the asset price distorting QE from ECB, yield on about 27 percent of euro-area sovereign securities are below zero, which is clinically insane, but again, when did we claim that we are living in a normal world. We need to always keep in mind that cost of capital is fundamental to valuation of any financial and hard asset and central banks, with their controversial monetary policies, are distorting the interest rates to levels where compensation for risk is not available. At the same time, thanks to the distorted interest rates, value of almost all financial and hard assets have now moved out of their logical space. Investors and less traders, need to keep that thing in mind, as, when the time comes for mean reversion and reality check, one’s capital preservation could come under serious threat.
Indian macro calendar was heavy with Balance of Payment, industrial output, consumer inflation and external merchandise trade. India’s current account deficit narrowed in October-December from the previous quarter on the back of slumping oil price. The deficit reached USD 8.2 billion, or 1.6 percent of gross domestic product, in the October-December quarter. That was lower than the deficit of USD 10.1 billion, or 2.0 percent of GDP, in the previous quarter and 0.9% of GDP or USD 4.1 billion it clocked during same quarter in 2013. There is also a more devious angle to the improvement in the current account deficit. Current account balance can also be seen as a sum of difference between private savings and private investment and government savings or deficit (S-I-G). Between FY08 and FY13, the sharp upswing in current account deficit, from 1% of GDP to nearly 5% of GDP was on account of massive rise in consumption, thanks to a strong economy and government’s fiscal push, causing private savings to decline. However, over the same period, the deceleration in investment in the economy was not enough to compensate for the sharp fall in net private savings. At the same time, governmen ran a higher budget deficit (negative savings).
A lower private savings and higher government deficit caused current account deficit to balloon.
Since FY13 to now FY15, the near 300 bps improvement in current account balance is more due to a sharp deceleration in consumption, due to economic weakness, anemic investment activity and much more spendthrift government. The bottom line is that a weak economy is largely responsible for the improvement in current account balance, and therefore the cause of improvement is neither sustainable nor desirable over the longer run.
In the BOP, net foreign capital inflows rose to the highest point in four quarters. Net capital account balance was at USD 23.4 billion, or 4.6% of GDP. Out of that, net FDI inflows rose to USD 7.4 billion, net portfolio inflows rose to USD 6.3 billion, net foreign currency loans of USD 0.7 billion and net inflows of capital to banks at USD 10.5 billion. Except for the inflows in banking system, all of the other components declined on a quarter on quarter basis. Net balance of payment stood at USD 13.2 billion, highest in the last four quarters.
Industrial growth slowed to 2.6 per cent in January, against 3.2 per cent in December 2014. For the April 2014-January 2015 period, the growth stood at 2.5 per cent, compared with 0.1 per cent in the year-ago period. The growth in January came largely because of capital goods production. Capital goods production rose 12.8 per cent, against contraction of 3.9 per cent in January 2014. The consumer durables segment continued to contract, with output in this segment falling 5.3 per cent in January. For April-January FY15, this segment recorded contraction of 14.2 per cent, against a decline of 12.5 in the corresponding period of FY14. Together with it, fast moving consumer goods declined, albeit marginally by 0.1 per cent. The manufacturing sector expanded 3.3 per cent in January, against 0.3 per cent in January 2014. During the April-January period of FY15, it recorded growth of 1.7 per cent, compared to contraction of 0.3 in the corresponding period of FY14. Mining output fell 2.8 per cent in January, against a rise of 2.7 per cent a year earlier. Electricity generation increased just 2.7 per cent, compared with 6.5 per cent in the year-ago period.
Consumer price index (CPI) inflation rose for the third straight month in February to 5.37 per cent. The increase in retail inflation in February was due to higher prices of food items, which rose 6.79 per cent during the month, up from 6.14 per cent in January. This was largely due to a 13.01 per cent rise in vegetable prices and 10.61 per cent rise in the prices of pulses. The government also revised the January figure to 5.19 per cent from 5.11 per cent reported earlier.
Over the next week, traders will keep a close eye on the US central bank’s monetary policy meeting. Fear of summer hike from the US Fed, ongoing QE in Euro land, almost daily dose of dovish talk from European policy makers and fear of showdown between Greece and rest of Euro zone are large enough factors which is making the US Dollar soar against the Euro. The currency war is in a full swing, where central bankers in the garb of fancy policy rhetoric, is engaging in a “beggar thy neighbor” policy of currency devaluation. The currencies Like Korean Won, Chinese Yuan and US Dollar are the laggards in the game of currency devaluation and we can expect at least S. Korea and China to become aggressive in that game in the coming weeks and months. Interestingly, the US economic data has shown an increasing weakening trend and that is not surprising to us. We have been pointing out how a stronger US Dollar and shale oil bust can choke US economic growth.
US fed fund futures are market driven measures of expectation of where US fed policy rate will be at different times in the future. In the graph below we have shown how the interest rate expectation for June 2016, 15 months down the road, is expected to be. What we find interesting is that US fed fund futures have remained stable around 1% mark. However, US Dollar has continued to surge higher, along with the US long term bond yields.
After policy rates have become zero bound in US, that is around 2008/09, US central bank has used QE enabled cash infusion in the financial system to stimulate the economic policy further. According to Ben Bernanke, an infusion of USD 600 billion tantamount to a hypothetical reduction in the fed fund rates by 75 bps. Hence, adjusting the US Fed fund rate by the quantum of balance sheet expansion which the US Fed has done, which is over USD 3 trillion, we arrive at a current fed fund rate of negative 4.5%. Such a massive monetary easing has enabled US stock market and then global stock market to levitate higher, in spite of a worsening economic outlook.
Over the next week, we expect a balanced outlook from US Fed, expressing concern over the weak global economic outlook, stronger US Dollar and then faltering US shale economy. As a result, we see the risk of near term peaking out in the US Dollar uptrend. We have been bullish since 61.40/70 levels on spot and we are continuing hold the same view expecting a test of 63.30/60 levels on spot in the USD/INR. USD/INR has been caught within a range of 61.00 and 64.00, with most of the trading confined between 61.50 and 63.50 on spot. Importers are comfortable covering their exposure between 61.00/62.00 levels exporters are comfortable hedging between 63.30/64.00 levels on spot. Technically, we favour a range of 62.00 and 64.00. However, incase of sustained move above 64.20, risk of a blow-off rally towards 65.50/66.00 can occur. We remain bullish on Rupee against British Pound. We have been bullish on Rupee against Euro since 73.00/74.00 levels and now it is trading around 64.00/65.00 levels on spot. We would like to wait for a consolidation and upward correction to materialise, before we think about adding fresh shorts. Yen remains in a tight range of 50.00/51.00 and 52.50/53.00 levels on spot. Indian 10 year yields have hardened sharply after an uptick in inflation, weaker Rupee, Fed rate hike fears and year-end profit booking from banks. However, we favour a range of 7.65/70% and 7.85/7.90% on 10 year for the time being.
