In a world of policy driven financial markets, follow the narrative, not just fundamentals

By: | Published: April 23, 2016 6:18 PM

Indian rupee has remained pinned down between 66.00 and 67.00 handles on spot against the US dollar, for the month of April. April is generally a quiet month, as data from past 16 years suggest that Indian rupee has on average remained dead flat.

Cash before month-endsWorld economy remains weak, though improvement in commodity prices have helped stabilised much of the high speed economic indicators around the world. For example, The Conference Board’s US Leading Economic Index (LEI) rose 0.2 percent in March, missing consensus expectations for a 0.4 percent gain. (Photo: PTI)

anindya-banerjee Indian rupee has remained pinned down between 66.00 and 67.00 handles on spot against the US dollar, for the month of April. April is generally a quiet month, as data from past 16 years suggest that Indian rupee has on average remained dead flat. First month of the financial year may be the reason why major moves do not occur. However, the same seasonality calls for a sharp uptick in volatility post April, into the summer months. On average, May-August has seen 1.5-5% of moves in the currency. Whether we get that kind of volatility or not would be dependent on world markets. Domestic economy is not expected to generate any headline which can drive that kind of volatility. However, this can be said that as good news for US dollar bulls, not so good news for Rupee bulls, whenever USD/INR pair has spend time building a base around key technical support levels, the ensuing moves have been quite sharp and on the upside. Therefore, we await triggers from the world markets in that regard.

World economy remains weak, though improvement in commodity prices have helped stabilised much of the high speed economic indicators around the world. For example, The Conference Board’s US Leading Economic Index (LEI) rose 0.2 percent in March, missing consensus expectations for a 0.4 percent gain. Stock prices were the largest contributor to the LEI in March. Interestingly, the Leading economic index was downwardly revised for the month of from a 0.1 percent increase to a decrease of 0.1 percent. The decline in February means that the LEI saw three consecutive monthly declines beginning in December, a clear indication of loss economic momentum in the US economy. However, there are pockets of strength in the US economy, something which I have written about in the past, and those are job growth and the housing market. For the week we saw unemployment claims plumb to a multi-year lows and housing projects started data show an impressive double digit growth during the first quarter over the same time last year.

Housing market in US, like the US stock market has been a major beneficiary of the stimulation effort of the central banks, keeping rates low and money supply pumped up. Housing has major trickled down effect on the economy and is therefore no surprise that it has played its part in keeping the US economy above water. Stock markets too has had a fantastic run since mid of February, as global policymakers managed to repair the narrative that central bankers have our back. In a policy driven market and not a fundamental factors driven market, dominant narratives can have immense impact on asset prices. The dominant narrative was threatened when last year policymakers moved towards a monetary policy divergence. Like a child, market repeatedly threw tantrum as it feared breakdown the central bank’s dominance, due to the lack of co-ordination amongst them. Central banks realized the danger in time and they stepped in to bring policies to convergence. In a convergent world, US dollar is not allowed to run higher unchecked backed by hawkish fed and dovish ECB and Asian central banks. As such a scenario threatens China, as they find breathing difficult, choked by deflation, bloated debt in the corporate balance sheets and massive overcapacity. Convergence is about calling a truce in the global currency war, where China is allowed a little more maneuverability. Convergence is achieved by allowing other currencies to appreciate against the US dollar, as Fed helps by leaning in favour of the dovish camp, risking its own credibility.

We love a convergent world because remember since 2009, a visible trend in the global financial markets has been the growing disconnect between fundamental picture, growth and productivity, and valuations of risk assets. This has been possible because central banks allowed us for the first time in human recorded history to experience what a central bank driven market feels like for various assets. This could be a reason where financial market observers have got the twist and turns of the market wrong, as we have relied more on traditional tools of analysis, when what drivers markets have been the narrative template, do they or don’t they have our backs. The period between August 2015 and April 2016 has witnessed numerous rounds of shifts in the narrative between positive and negative quadrant. In order to be able to navigate with a little more edge one has to be able to gauge these shifts as they happen. I have already touched upon the two key markets to keep an eye on understand the shift, one is the currency market, US dollar and Yuan and other is the oil market, be in WTI prices or Brent prices. As long as the positive spin is working its charm, oil prices should levitate along with weaker to stable US dollar. If they do not, we can start seeing the breakdown in the truce and with it the narrative and finally the risk appetite.

The game of narrative is extracting heavy economic price from various participants. As I have written about it in the past, world economy is going through a rebalancing phase, something like what happened in 1930s, where savings-investment imbalance is worked away slowly and painstakingly, debt levels fall to manageable levels and world economy heals. In such a scenario, it can cause political and social disillusionment, as wedge between haves and have nots grow wider. We are already seeing it ramification, with right and left wing politics raising its head all over the world and the moderate camp is becoming endangered species. In such a scenario, if Europe and Asia accommodates the massive supply lines of China by allowing Chinese Yuan to depreciate against their own currencies, either through a weaker US dollar (CNY is loosely pegged to USD) or through a direct devaluation exercise by the Chinese, it will mean that these economic continents face more domestic backlash from their domestic industry and exporters as they feel crowded out by Chinese supply. Chinese on the other hand, would prefer devaluation due to US Dollar weakness than a direct devaluation like the one they did last year and early this year. In case of direct devaluation Chinese fear a risk of a surge in capital outflows, which can destabilize an already bloated and stretched financial system. Amidst these, Americans have become the church bell, due to them being the global currency, anybody and everybody can look to pay for blessing by simply ringing the church bell and extract the demand from the US economy. Therefore, I do not believe this truce can last long and hence we need to keep an eye on the developing narrative.

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