Forecasting is a tough business as external conditions are changing rapidly and all models that interpret the past are quite impotent when extrapolating the same into the future. Less than a month ago, the dollar appeared to move towards parity with the euro, but it has started falling quite sharply all of a sudden. Our own inflation numbers are hard to predict even if we discount the fact that nobody believes prices are coming down. The IIP numbers have become an enigma, as was witnessed when the February numbers were announced. When 38% of the index, as represented by the core sector, went into the negative zone, the basic, intermediate and capital goods grew smartly to counter the negative growth in consumer goods to yield a reasonable growth in the IIP. Therefore, today models are passé. The question, therefore, is: Do the markets do a better job?
The “efficient-markets” hypothesis says that when information is equally available to all participants, and everyone uses them judiciously, then the markets deliver the best results. The issue really is how does one interpret this data? We all know that when dollars come in, the rupee strengthens, which may not be desirable after a point of time. We then expect RBI to intervene. But everyone has their own hypotheses, and that makes it difficult to first guess the market. Market psychology becomes important.
The futures market provides a clue here as they are supposed to tell us how the market thinks the prices will behave months down the line. The futures prices are defined as the cash or spot market price and the cost of carrying which, in turn, is simply the interest rate. While this is the theoretical definition, the price actually takes into account all the information that is available while looking forward. Say, for October, when the harvest season starts for the kharif crop, the futures prices take into account the conjectures on the crop arrivals based on signals received today. If it is a currency, then there are subjective guesses, which get aggregated to reach the equilibrium price.
The futures prices present an interesting picture. In the commodity market, three significantly traded products are soyabean, its derivative soya oil and guar seed—all of which are kharif crops. The NCDEX prices broadly shows that the soyabean October and November contracts prices are ruling at a discount of 9.5% and 6.5%, respectively. For soya oil, it is around 1.5-1.7%, and for guar seed, there is a premium of 17-22%. Guar seed is a ‘classic crop’ as it goes beyond the realm of a normal crop and becomes a barometer for rainfall. If the prices are at a premium, the market expects the monsoon to be below normal which is reflected in higher prices. The soyabean story of discount indicates that the crop is expected to be largely satisfactory and hence prices are to remain insulated from the monsoon influence. Last year, while production was down, the prices remained steady for soyabean. Part of the reason could be that the global prices were declining; and as we are an importer of edible oils, lower output had little influence on prices.
The forex market is not too developed, but the NSE futures platform shows that the December contract for the dollar indicates a price in the region of R 66.30-66.50. Now, few forecasts have gone this far, and it is expected that a region of R64-65 would be fair enough given the fundamentals as well as external developments, including the Fed action, ECB easing, China easing, etc.
The interest rate futures market is mostly illiquid and hence the prices are not really representative of what may be in store for the players. The June 8.40% 2024 bond is still going at a price close to what is in the market today, at 103.52. It is more a case of static expectations here.
The global scene is even more interesting because there is extreme caution and all actors are playing it by the ear. The highest volumes of trade are in the euro-dollar currencies. Given that the value today is $1.11=1 euro, this market should give us some signals of how these currencies will behave going ahead. The December contract however is quite static at 1.11 which looks puzzling, given that the US economy is probably the only bright spot on that side of the globe and the Fed is all set to raise rates at some point of time. Logically, the dollar should be getting harder. But the market is assuming status quo. Also gold, which normally goes with an inverse relation with dollar, is also working on static expectations and is trading at near-par with the spot price, at $1,190/ounce.
The crude oil price on NYMEX is working on similar assumptions of static expectations. WTI is going at 7% premium and Brent at around 6% for December which still remains static in the larger sense of remaining below the $70 mark. Now, with no fresh capacities being built and shale productive capacity reaching its end, any recovery in the global economic prospects will exacerbate the “rising demand and limited supply” equation, leading to higher prices. As is evident, however, the market is not giving this scenario much weight and prefers only a mild adjustment, more like adaptive expectations.
Hence, the global picture does paint a wait-and-watch scenario where traders are working on the status quo prevailing. This could be because no one expected the oil price to come down so sharply and hence there is the assumption that the immediate-term conditions will also extend into the medium-term. Also, the global recovery and policy actions of central banks seem to have sent different signals, making it hard to interpret.
It is argued that markets follow a random walk and hence are hard to predict. The best that one can forecast is: Assume that what happens today will happen tomorrow. But when the 6-month futures is almost the same as what is prevailing today, it can be concluded that the market is conservative and not willing to guess. “No change” appears to be the solution. Not very inspiring, given the econometric advances made in the world of economics.
The author is chief economist, CARE Ratings. Views are personal