Bank of Japan, unexpectedly decided to take baby steps in monetary policy easing.
There seems to be a shift that is happening in the developed world, away from monetary policy as a way to get economic growth going towards fiscal policy. There is growing acceptance that monetary policy has reached its limit and further actions in that area would only aggravate the cost of exit. Demand remains constrained as private sector is not able to participate like they used to in the debt creation process pre-2008/10. In such an environment, the only unspent bullet remains the government sector in the developed world. Emerging markets had done their bit of fiscal stimulation, back in 2009/11, and in fact they over did it, leading to inflation-debt & currency crises over the last few years. Now as the emerging markets use their monetary policy levers to stabilise their economies, it is the developed world governments who have to step on the plate with their enhanced deficit programs. Thus the penchant for helicopter money, a combination of fiscal stimulus financed overtly by the central banks.
Bank of Japan, unexpectedly decided to take baby steps in monetary policy easing. They only increased the ETF purchases to JPY 6 trillion from previous pace of JPY 3.3 trillion. They did not move on interest rates or on the purchases of the government bonds. Bank of Japan has placed the ball on the court of the government, where a fresh stimulus plan of nearly JPY 30 trillion is expected to be announced this week. However, Bank of Japan has kept the doors open for a fresh monetary policy stimulus somewhere in September. It is also around the same time, the European Central Bank is expected to re-evaluate options for further easing. Reactions of traders were on the expected lines, to buy Yen. Yen rallied 3% against the US Dollar and less so against other currencies. We have long argued that a strong Yen is beneficial for the domestic economy of Japan as it is consumption lead. We would like to see the specifics of the fiscal plan. One needs to see how much of “fresh water” is the package and how much of that “fresh water” is scheduled for 2016. Whether the plan will stimulate investments over consumption or the other way around. It will be interesting to see whether this is start of a new phase of policy making in the developed world, where politicians get involved and central banks vacate space. A hands-off approach from BoJ and a hands-on approach from Japanese Ministry of Finance would mean Yen would stay strong but that may not hurt the Japanese stocks, provided much of the fiscal plan is credible and front loaded.
Across the Pacific, economic data from US has improved in Q3. Consumer sentiments, retails sales, housing sector and even jobs data has shown impressive growth. However, business investments continue to be a drag on the economy. Durable goods orders fell for the second month in a row in June, bringing the three-month moving average to a decline of 4.0 percent. Core capital goods orders, a key series for predicting future equipment investment, rose slightly in June; however, the series remains down 6.6 percent on a three-month annualized basis. Industrial sector has been hurt by a confluence of weaker commodity prices, stronger US Dollar and lack of growth optimism around the globe. One look at the global bond yields shall confirm the expectation for future economic growth. With nearly USD 13 trillion of debt trading with negative yields and greater number below 1% rate. Interestingly, merely 2 years back there was barely no debt which was below zero. It is no co-incidence that over that same time period, global commodities have crashed. Both those indicators, commodity prices and global bond prices have self-reinforced each other. They together are painting a gloomy picture of the world economy.
US economy though remains one of the few bright spots in the global economy, including India, Mexico and a few countries in South Asia, is also witnessing a volatile trend of growth. Just released Q2 GDP numbers have shown that economy grew by barely 1.2% in Q2 on a year over year basis, down from 1.6% in Q1. We like to use the year over year comparison and not the quarter over quarter annualized data which makes rounds in press. Former allows an apple to apple comparison when seen on a relative basis around the world. GDP growth is weakest since Q2 2013. Personal consumption growth has held up at 2.7% but it is the private investment which has knocked down GDP. Latter has contracted by 3.4% pace, weakest since Q4 2009. Exports have contracted by 1.2%. All in all US Fed will not be too enthused by the economic data. Therefore it is no surprise that odds of a rate hike has now diminished to 30% by December 2016. A plunge in the odds have struck the US Dollar on the solar plexus. US Dollar plunged anywhere between 1-3% against most major currencies globally. Indian Rupee too appreciated towards 66.70 by the time offshore market closed. Chinese Yuan appreciated by 0.5%. Bond yields have plunged further. US Bonds are not far from the all-time lows of 1.32% it touched a few days back.
In an environment of abundant global liquidity, diminished threat of US rate hike and yield starved investors, money may continue to flow into the sub-continent. Indian stocks and bonds continue to move higher. Indian 10 year bond yields are now at the lowest levels since 2009 at 7.16%. Abundant domestic liquidity and expectation that the new governor may be more dovish than his predecessor, is also an added factor of attraction. Monsoons have been more or less good. A bumper harvest can keep food inflation at a check and lower oil prices can keep fuel inflation low. All in all we can see further bull flattening of the Indian yield curve and further rally in the long term bonds. There is a virtuous relationship between bonds (cost of capital) and equity prices. Therefore a robust bond market can propel equity markets to greater height. What all this means for the Rupee? It is unequivocally bullish for the Rupee. It is the not only the macros which makes it attractive but also the impressive volatility adjusted carry which makes it more luring. However, over the past two years, we have played USDINR as a managed pair, where the visible hand of RBI crafted an upward gliding but low volatile pathway, from 58.30 to 68.00/69.00 levels.
Now with a change at the helm of RBI, we are not sure whether the existing FX policy would continue or not. We would welcome if RBI allows market to have a greater say in setting the price, but it would come with an increase in volatility. We can then see large trends appear and sustain. For example, currently with surge in inflows and large carry trade selling interest in USDINR forwards/futures (onshore and offshore) there is a risk that Rupee may appreciate further against US Dollar. There is a possibility that with US Dollar under pressure against most currencies including Chinese Yuan, RBI may be comfortable with Rupee appreciating further. We would keep an eye on the 66.60/80 region, if that fails to hold, the pair can decline towards 66.00/66.10 region. Against the currencies Euro, GBP and JPY, we can see more mixed trends. JPY remains strong and demand could be seen on decline. However, we see rallies in GBP as opportunities for exporters to increase their hedges and against Euro, Rupee is going to be more range bound.