Indian rupee, along with a whole host of currencies across the emerging markets (EM) sphere, has had two good weeks back to back. Many of these currencies appreciated anywhere between 2-8% against the US dollar. A sharp rebound in commodity prices has triggered a relief rally in many of these EM currencies. Indian rupee has benefitted from a better than expected Union Budget and then gathering talk of a rate cut from the RBI in the next monetary policy meeting in April. At the same time, further monetary easing from the central banks in Japan and Euro zone has added to the risk-on sentiments across the EM. I would refer to the rally of the last few weeks as a much needed sentiment rebalancing move. Sentiment had turned overly bearish and even fearful and cash levels of institutional managers increased to record levels. The ongoing rally, if it sustains for a few more weeks, can help rebalance much of that extreme positioning and then pave a way for the next leg of the asset downturn to get underway.
The corrective rally got a boost from the European Central Bank (ECB), as it went nuclear with its next leg of easing. The sheer scale of easing, with almost all the tools being unleashed at the market, in our opinion appeared out of place with economic reality. Euro zone economy had stabilised over the past three years. From the depths of recession and depression and financial calamity of 2011/12, we have seen economic activity indicators and credit market indicators stabilise. Not just in the core economies like Germany, who have extracted a larger benefit from a weaker Euro and low interest rate, but also peripheral economies like Spain have benefited too. Inflation has been subdued but credit growth has improved. Yes stock markets have taken a knock but it must be noted that unlike, Americans or British, Euro zone citizens do not derive a disproportionate amount of their wealth from the stock markets. In Euro zone, much of the corporate fund raising happens through banks and non-banks. At the same Euro has depreciated significantly against major global currencies, which is helping Euro zone nations stay ahead in the global currency war. Then it defeats my logic what prompted ECB to go ballistic. It seems they are not realizing the danger of trying to impress/shock financial markets. In trying to devise monetary policy on the go, they may be venturing into a dark world of negative interest rates, where the traditional logic of economics and finance may break down. They may end up seriously impairing the financial system with such measures. It risks pushing ECB, and also BoJ, to a point of no return. Let us take a look at the measures that ECB announced last week:
1) Main Refinancing Rate Cut to 0% from 0.05%
2) Deposit Rate Cut to -0.4% from -0.3%
3) QE Increased to 80billion Euros Per Month from 60Billion
4) Introduced New 4-Year TLTROs
5) Expanded Asset Purchases to Include Corporate Bonds
6) Lowered 2016 and 2017 GDP and Inflation Forecasts.
Post announcement, Euro against USD, which had fallen to 1.08 against the US dollar, reversed direction and rocketed upwards above 1.12. The reaction was very much like what happened to Yen post Bank of Japan’s monetary policy. The sharp reversal in Euro can be partly attributed to the fact that ECB chief sounded out that there may be no more cuts in policy rates in the near future. Post-Draghi, attention now shifts to Bank of Japan’s monetary policy and then the all-important US Fed policy. We hope that BoJ does not push more on negative interest rates, as it should be clear by now, that negative interest rates are not being well received by market, for obvious reasons. NIRP has adverse impact on the banking system, Pension Funds, Insurance Companies and Money market mutual funds. It may end up pushing interest rates higher for countries where lending occurs primarily through the banking system, for example Japan and Euro zone. With ECB having thrown everything into the kitchen sink, and BoJ thinking about more, US Fed can sound quite hawkish. Since last US Fed meeting Dollar has weakened against most currencies and economic data has been ok. Though one can always say US Economy is gradually decelerating, with service and manufacturing showing strain, but headline data has not been damaged so much for the Fed to go full dovish. Therefore, US Fed may balance a no hike in March with a hawkish stance, which can be negative for the emerging market currencies.
India released its industrial production statistics for the month of January 2016. Industrial activity decelerated for the third month in a row. In January IIP de-grew by 1.5%. Mining growth slowed to 1.2% in January and manufacturing contracted by 2.8% but electricity output accelerated to 6.6%. Based on the sequential trend, it appears that momentum remains positive for mining but rate is decelerating, manufacturing is still showing positive momentum, but stalling and electricity is having negative momentum, which is accelerating. Among use-based industries, capital goods, which represent investment demand in the economy, contracted 20.4%, while consumer goods output did not see any growth from the same month a year ago. Within the consumer goods segment, consumer durables grew 5.8% while consumer non-durables contracted 3.1%. The weak trend in IIP over the past couple of months can be corroborated by car sales statistics, which has shown contraction over the past two months. According to Society of Indian Automobile Manufacturers, car sales in India declined for the first time in 14 months in January as discounts dried up at the start of the New Year and auto makers corrected inventory at dealerships the previous month. The trend continued in February, with domestic passenger car sales declining 4.21% to 164,469 units.
Next week, is packed with economic data from India and abroad. US will be reporting a whole host of business sentiment indicators, as well as the all-important US FOMC meeting is scheduled on 16th March. At the same time Bank of Japan will be meeting to deliberate upon its monetary policy. BoJ is expected to maintain a dovish tone but no new measures are expected from them. Interestingly, a divergence has developed between US/global stock market and US Dollar Index. US Dollar Index is heavily weighted towards carry currencies like Euro and Yen. Therefore, a weak Euro and yen or strong US Dollar Index goes hand in hand with a positive trend in the global equities. However, this time, both are not moving together, which prompts us to think that one has to give. Post FOMC, if US Dollar Index does not rally, which we expect it would, then we can see a negative reaction in the global equity markets as the two major themes converge. Keep an eye over there.
In India, next week, traders will be watching the release of Feb inflation statistics, WPI & CPI along with that merchandise trade numbers will also be released. Especially a softer CPI can trigger further rally in the Bond markets, where 10 year is hovering around 7.65%. We can see more receiving in the Dollar forwards, as liquidity is expected to ease in the coming days and weeks. At the same time, Rupee may find support from a softer CPI. However, I do not expect much upside in Rupee beyond 66.70/80 zone. I believe the zone between 66.50 to 67.00 is a sweet spot for importers as demand from the central bank and oil marketing companies can appear in order to support competitiveness.