Gate To Perdition

The central bank’s dry powder to defend the rupee may be inadequate

Skittish investors are reacting to every data point and the latest lower than expected US jobs data has turned out to be cause for celebration. They certainly seemed to have sniffed its potential to scare the ‘spectre’ of a 25 basis point Fed hike away. This behavior of market participants is a far cry from when the market used to run up after a Fed hike because it signaled an economy on the mend. Most markets including the Nifty closed up 2% today. The Chinese who could have done with some excitement in their market missed out due to a public holiday and might want to play catch up tomorrow. The continuing nervousness in the market despite a continued ECB and BOJ liquidity deluge is hard to explain. The US 10-year now yields 2.02% after hitting an all-time low at 1.47%. Surprisingly, the lowest that it traded during the Lehman crisis was 2.2% and that was supposedly the equivalent of financial Armageddon.

An additional factor this time is the redemption from Middle Eastern sovereign wealth funds. The low realisation from crude is eating into their reserves and hence their welfare spending. Unlike during the financial contagion, crude has been slow to pullback and the current price of around $50 is biting hard. The biggest OPEC producer, Saudi Arabia has reportedly pulled out $70 billion across equities and bonds and more could follow. Given the fallacious correlation between real demand and the price of crude, nothing stops the prop desks of major banks from shoring up crude to an agreed level to stem further redemption. Unless all hell breaks loose, this seems eminently plausible.

While the Sheikhs and the Emirs will be content with the outcome, crude backing up higher will certainly not be great news for India. Our macro acquired a new shine this time last year as crude plunged from $105 to $50. But despite the halo and amid talk of RBI intervention, the INR did not trade above 58. And now at 65.30, we are closer to 67 than the 61.50 last year, the level that the RBI would have ideally wanted it to be around. Also, if one ignores today’s 2% bounce, having shed its gain, the Nifty is more or less where it was last October.

We are also losing the yield differential cushion and a rupee under further pressure would be bad news for foreign investors. The rupee has lost 6% over the past year and just over 5% year-to-date and the return of a risk-on trade could lighten the RBI’s dollar reserves. With an eye on increased FII-debt flows, the governor has increased the limit in his latest monetary policy, but incremental short term flow cuts both ways. For now though, bad news definitely seems to be good news, tomorrow be damned.