Wrong Move?

The US Fed, in its last policy meet for the year, held on 15th and 16th of Dec, decided to break it’s near zero interest rate trends. The US Federal Reserve on 16th Dec, 2015 decided to raise its interest rates for the first time after the sub-prime crisis era. Although, the hike was anticipated much earlier in the year, lack of strong data in terms of unemployment rates and inflation was a hindrance. Ultimately, on the basis of fairly strong data, the Fed has decided to step on the gas. The question is” was this a wrong move”? In this blog, I will focus on the data considered by thr Feds for a policy action, inflation targeting, rationale behind the rate hike decision, why is the hike unconventional and the history of the impact of such unconventional measures. To conclude, I would provide an insight on the policy modes of the major economies, the likely impacts on the US economy, global growth and the financial markets worldwide.

The Federal Reserve, in its final policy for the year, increased the interest rates by 25 bps from 0%-0.25% to 0.25%-0.50%. Fed was focusing on the data from the past 5 years to understand the feasibility of a rate hike. For the readers, it is important to know that a rate hike will start taming inflation and choke the growth in the medium term. Feds have been closely tracking two critical indicators namely, unemployment rate and the retail inflation numbers. Feds had their targets for unemployment rate to drop below the 5% levels while inflation rates to touch 2% trending northwards. The growth rate so far has been on the lower side, but as every other developing and developed economy, the US is has a focused inflation targeting.

Here’s a graph to explain the readers briefly the interest rates and inflation trend:

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Interest Rate Trend 2005-2015
Fullscreen capture 12232015 123056 PM.bmp
Inflation Trend 2005-2015
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Feds Target Line Not Crossed

The rationale of the US Fed behind the rate hike was a fairly upward trending inflation and lower unemployment rates. The above images show that, despite not achieving the inflation target and the unemployment rate benchmarks, the Fed increased its interest rates in a non conventional manner. The tone of the policy statement indicated that they are expecting the inflation figures to rise further and the unemployment rate to continue its downward trend as shown in the graph. Inflation is rising but the average figures for the year 2015 is 0.5%. It is unlikely that the figures will rise up to the 2% levels  in the near future due to lack of domestic demand in the US.  On the other hand, a rate hike will choke the growth as well as tame inflation, which will beat the purpose of the rate hike  in the first place. Secondly, the Fed said they expect the unemployment rate to inch downwards from here on. But here’s what has happened from 1971 till date to the unemployment rates whenever the interest rates have been change. Unemployment is directly related to the movement of the interest rates. The below graph and the movements suggest that even the intent of bringing the unemployment rate down is not achieved with a rate hike. Its a challenge from here on how the Feds are going to contain the effects or if I may say the ill-effects of the decision.

Wherever-US-Fed-Funds-rate-goes-unemployment-follows-eventually
Whenever interest rate has increased, the Un-employment rate has increased as well and vice versa

Lets take a look at the history of the effects of unconventional policy actions. European central bank raised the rates twice in 2011, killing a nascent recovery and plunging the euro zone into a double-dip recession that it is still struggling to overcome. In between the years 2004-06, Feds steady quarter point increase in the rates (which was an attempt to avoid the bubble creation), was not enough to stop the implosion of the housing bubble in 2008. In the above mentioned scenarios, the problem was either the central banks acted too slow or too fast, whereas it would have been prudent to take appropriate actions. 

With growth still sputtering in Europe, the ECB has been embracing the tools used by the Feds years ago to revive the economy i.e Quantitative Easing. ECB has kept its rates to near zero levels to try and revive the economic conditions with QE, although the revival might take a little more time than expected. Whereas in Asia, PBOC (People’s Bank of China) is also on a easing mode. Similarly Japan is keeping its interest rates at rock bottom levels to encourage growth. India as well has joined them by reducing its interest rates by almost 125 bps from Jan 2015. With the globe on easing mode, it is going to difficult for the US to justify its tightening with the global growth being already quiet subdued. The growth rates for the US in the first half of 2017 are expected to be on the lower side because of the tightening. US also has been a reasonable contributor to the global growth, and with this tightening we can expect a much lower share from the US and consequently lower global growth. The USD as well is expected to harden against the rest of the currencies hurting the exports and thus undermining the trade balance. Markets all over the globe are expected to reap fairly low returns as compared to last year in the medium term. To sum up, with its unconventional policy actions of a hike when the rest of the economies easing to spur growth, the Fed has increased the probability of a further slowdown in the US. If there is no inflation, the growth cannot happen or if I may say if there is no growth, there might not be any rise in the inflation. Currently, US does not have either in place (Insufficient growth to drive inflation and insufficient inflation to drive growth). But, on the brighter side, with US, China, Europe and Japan on a slow lane, India might be the star performer in the coming year with highest growth rate in the emerging economies as well as the world. But, with winter session wiping out without the GST passage, the path on the fast lane does not seem to be easy. However, the prospects for India are significantly good from here on with an expectation of the reforms rolling out in the budget session.

Thank you.

🙂

 

Indian Markets – Back To Square One

The Indian stock markets witnessed a sharp correction in the recent period. There have been various reasons for the continuing sell off which is threatening the bullish stance. The reason of naming this blog as Back To Square One is, the Indian markets have corrected to the tune of almost 15% starting from Jan 2015 which has led to a complete washout of the one year nifty gains. The markets have corrected back to the Aug 2014 levels in the past 9 months. In this blog, we will discuss the reasons of correction, the sharp fall and a bit of prediction of the coming short-term, medium term and long-term expectations.

Markets reached their all time highs during the 2014 period after the NDA govt took over. It was expected to do so in 2015 as well. In Jan 2015, markets were at 9100 levels which was triggered by the first rate cut of the year. But we saw that the markets could not sustain those levels for even a day. The stocks were valued at 24x P/E by that time, which indicated overvalued position  and now they have come down to 16x levels. The correction was expected from that time itself. Apart from this, the corporate earnings growth of Q4 was disappointing for the markets. The parliament monsoon session faced a continuous logjam for the entire period thus making the parliament session unfruitful in terms of reforms. This led to further correction in the markets.

THE PARLIAMENT SESSION OUTCOME
                                             THE PARLIAMENT SESSION OUTCOME SO FAR

While the economy was trying to settle down in April, the Shanghai Index fiasco kicked in. This led to a weak sentiment among the global markets. The Shanghai index corrected sharply by around 30% compared to the past year levels. The Chinese stock market regulator tried everything to curb the outflow post the Grexit fears and hardening of dollar against various currencies, but ultimately failed to recover. China, being one of the fastest growing economy for the past 7 years, started to show signs of slowdown. The FIIs took this as a signal that emerging economies have starting becoming risky because of the high valuations and might correct. With that fear, the FIIs started pulling out hot money from the emerging economies including India. As we know, the Indian markets are driven by FIIs inflows, the outflows starting affecting our index as well. The mutual funds tried supporting the levels of the market by almost equivalent levels of buying, but could not sustain for a long-term period.

Shanghai Index Movement Past Quarter
                        Shanghai Index Movement Past Quarter

The above mentioned facts were for the period up to August 2015. Last two weeks, starting from 22nd August 2015, markets witness tremendous volatility. The volatility was driven by auto sector, IT and Banking. RBI, in the last week of August gave an in-principle nod to 11 payment banks and might declare small bank licenses in the month of September. The payment bank licenses led to the fear of decline in the deposit share of the existing banks. The bank nifty hence corrected heavily with the declaration by RBI. The nifty corrected as well, since banks hold 21% weightage in nifty. The core sector growth on the other hand, slowed down thus indicating that we might have weaker IIP numbers since core sector growth has a weightage of 38% in calculating IIP.

NEW PAYMENT BANKS
                  NEW PAYMENT BANKS

In August last week, Nifty declined by almost 500 points.Most people took this as a crisis situation. Actually the correction was because of the sell off by brokers. SEBI, in its move towards protecting the investors interest, banned 59 brokers from trading on stock exchanges. They further asked the brokers to square off all the positions in the pre-open session next day. Thus, the markets corrected sharply on a single day. It was not the global woes but also the domestic sell off that led to the correction.

The markets so far have indicated that they are now looking for reforms.  In the short-term, the markets will eye the China woes and domestic indicators and are expected to be volatile. In the medium term, the markets will hope for a rate cut looking at the current conditions and GST Bill passage and might be on a bullish stance in the medium term. In the long-term, the markets are going to be bullish in nature as India might surpass China and become the fastest growing economy. Markets are now looking for a trigger which will take it back on the bullish path. It is waiting for the RBI to cut rates as well as for some reforms in terms of GST Passage. Till then stay invested is the key here.  

Next blog will be an investor education centric article. The question is ” Can your stock picks act as a liquid FD? “. Think about it. Thank you. 🙂


Grexit and Its Effects on the World Economy

The exit of Greece from the Euro Zone, nicknamed as GREXIT, is the currently trending topic of the global economy. Grexit is looking almost inevitable at this point of time as far as the talks between the Greece Ministers and its creditors are considered. Amidst all the events, we will take a look at how the world economy might be affected and how Indian markets might react.

Let us start with a small recap on how this situation of a default by a country actually arose in Greece. Has it happened all of a sudden? Or has it been an effect of a long-term sustained stressed situation? So here is whats been happening in Greece in brief right from 2008, the year popularly known as the year of Sub Prime Crisis. Although it has no direct correlation with the current situation in Greece.

Just when the world was recovering from the global slowdown of 2008, with the fear of default and in the hope of getting assistance, Greece announced that it was understating its deficit burden from quiet a long time. The news came as  a complete surprise to the markets and while analyzing this situation the world started questioning the ability to payback its debt obligations. Greece had a debt to GDP ratio of around 146% by 2010. Due to which the Greece bonds were declared as Junk bonds( precisely non investment grade bonds), which prohibited them from accessing the bond markets.

karikatur für tribüne- skeptische blicke

In this adverse situation, the International Monetary Fund (IMF), the European Central Bank (ECB) and European commission(EC) came to rescue with a proposal for Greece to initiate a revival. IMF, ECB and EC, together popularly known as the Troika, extended a loan of 110 Billion Euros in its first lot, and another pack of 130 Billion Euros. Although this assistance came with certain conditions like cutting down Govt debt, structural reforms and privatization of Govt Assets. These severe austerity measures were not taken well by the public. However, this continued for a year and then finally a premature election was called for in Dec 2014 since the public wanted a new govt to handle the situation. The new Govt in power refused to accept the measures suggested by the Troika for its revival against a huge sum of 240 Billion Euros. From that time onward, there has been immense political uncertainty, which is indicating that the Euro Zone might probably let go off Greece.

Currently Greece is left with two bad choices to make and its been left to them to choose whichever might lead to lesser repercussions. Following image might just give a brief idea of the condition:

grexit-comic

In case if Grexit happens, then the stock markets might see turmoil for at-least a medium term period since many companies in various countries have immense dependency of their revenues from the Euro Zone. Before we look at what would happen to Indian Markets, let take a look at what would happen in general on the event of a default. Grexit would mean distress in the euro zone, depreciating euro against the major currencies. Dollar would strengthen immensely over this event, thus putting further downward pressure over rupee. Apart from currency markets aspect, it might even lead to FIIs outflow since the emerging markets as a whole would become risky and the investors might want to invest in safer assets such as US Treasuries, especially in the short-term. Greece on the other hand might be locked out of the international markets. The crisis doesn’t end there, Greece will have to adopt its old currency, drachma, which will lead to its devaluation on default but the debt will still have to be repaid in terms of Euros, leading to further distress.

Indian Stock Markets on the other hand, might become the favorite destination to invest in the long-term, looking at the simultaneity of Euro Zone crisis, the US showing slow recovery, China showing slowdown, Shanghai Index correcting almost 20% being over valued from the past year and IPOs woes, and all time high forex reserves with RBI to control currency movements. Anyway the markets would not be affected to the extent of correction of 2008 phase since there are not many un-hedged exposures from the corporates. The only issues might be a few companies being exposed to the weak Euro as a part of their revenue generation and the new 30 IPOs lined up to enter the markets. However, in this decisive time it will be interesting to see if Greece handles the situation wisely or will choose to default.

Next up might be something on markets, in case Greece defaults on its 1.5 Billion euro payment to IMF.

Thank you. 🙂