Global economies got into significant growth pressure since
2008-2009 and it was no surprise to see Central Banks shift into ultra-dovish
monetary policy stance with liquidity support through innovative Quantitative
Easing (QE) asset repurchases products along with sharp decline in refinance
policy rates. During this period FED fund rate eased from over 4% to near zero
percent. The combination of QE and ZIRP (Zero Interest Rate Policy) regime was
intended to discourage savings and push consumption with the agenda to create
additional demand (for goods and services) for higher capacity utilisation, and
thereafter to expand capacity; all taken, to arrest deceleration in growth,
enhance job creation and to get the growth momentum back on track through
aggressive dosage of monetary steroids. It has been 5 long years, and the
result is yet to be realised! No doubt, the pace of deceleration is arrested
but growth pick-up continues to stay diluted. The expected demand-led
supply-expansion is yet to materialise. The beneficiary obviously is the
financial markets; in the absence of attractive growth-investments, money
started chasing financial assets across equity, bonds and commodities with most
gains on the equity assets. During the period 2008-2009 to 2014, US DJI index
is up by 169% (from 6469 to 17410) and S&P 500 up by 204% (from 666 to
2024) at an alarming annualised rate; tracking near-zero short-term money
market rates, medium-long term bond yields dropped sharply while Gold rallied
by 180% (from 680 to 1920). Despite growth pressure, Brent Crude rallied at an
accelerated pace by over 250% (from 36 to 128) with combination of
geo-political issues. All taken, liberal money policy provided great return to
the investor community without significant pick-up in consumption and economy
asset creation! India did get the benefit of global liquidity as external
monies chased relatively higher growth trajectory in emerging markets and
elevated money market yields. During this period from 2008-2009 to 2014, NIFTY
is up by 270% (from 2252 to 8350) while Rupee down from 39.20 to 68.85 (by 75%)
before stability at 58-63. It is good for Indian equity market despite struggle
with structural woes from lower growth, higher twin deficits and elevated
inflation adding pressure on the exchange rate, thus providing similar exchange
rate adjusted return for FIIs. The take-away is that while the Government and
Central Banks are still under pressure on deterioration in macroeconomic
fundamentals, investors are in cheer with great returns on their monies with no
worry from sluggish growth momentum!
How long this cycle will last? The extended phase of ZIRP
from 2009 to 2014 is worry. There were similar phases from 2000-2001 to
2003-2004 (FED fund rate dropped from 6.5% to 1%); up from 1% to 5.25% (from
2004-2005 to 2007-2008) with short phases of near zero interest rate regime
before sharp spike on monetary policy driven growth momentum. But this time,
despite 5 long years of monetary support, there are limited signals of growth
recovery, which should emerge as serious concern for investors going forward.
Commodity assets have already taken the cues; Gold is down from 1920 to 1160
and Brent unwound gains into 82. US long term bond yields have also started
inching up but finds support on extended ultra-dovish monetary policy stance of
ECB and Japan. The contradictory positioning of FED and other major Central
Banks is the only comfort for global investors at this stage.
What is the way forward? FED has already ended the life-line
QE support with guidance of shift into rate-hike cycle in 2015. Despite other
major economies in extended pause, impact of US will be felt in global markets.
The start of rate-hike cycle by FED will begin unwind of the sharp 2009-2014
appreciation in equity assets and add to current bullish momentum on the USD.
Commodity assets having unwound major part of liquidity-driven rally will get
support on growth comfort for consolidation with diluted bearish undertone. US
10Y Bond yield will get the focus back into 3-4%. Over all, leveraged
investments into financial assets will get unwound to take money off the table
with limited appetite for fresh investments. Indian financial markets cannot
stay ring-fenced despite domestic euphoria nor take comfort from upside
momentum in growth momentum or ease in inflation or significant improvement in
fiscal deficit. The immediate impact will be felt in India equity assets and
Rupee exchange rate with stability in long term India bond yields. What is
uncertain at this stage is the timing of shift in global tailwinds into
headwinds and extent of FII exit from India, which may not extend beyond
2015-2016!? The risk on India financial assets are more when 2009-2014
appreciation is driven by global liquidity (and foreign investors) despite
hawkish monetary stance of RBI, and there will be limited bandwidth for RBI to
turn dovish when external headwinds emerge strong.
At this point, the guidance is to stay cautious and prudent
as liquidity-driven appreciation of financial assets have gone a bit stretched
and financial markets are expected to get into correction (or reversal) mode
till clear signals of pick-up in growth momentum emerge to bring-in growth-driven
appreciation on financial assets! May be, the extended party is in its final
round for shift into consolidation mode before start of economic fundamentals
driven bull phase.
Moses Harding
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