Recovery efforts pay off in the first half of 2009

July 2, 2009 — Mitul Kotecha

At the end of last year it looked distinctly like the global financial system was on the verge of meltdown and that the global economy was about to implode.  The change in market sentiment since has been dramatic.  Various banking sector bailouts, the pledge of as much as $2 trillion to support the US financial system, passage of the $819 billion stimulus plan by the US administration and G20 agreement pledging $1 trillion for the World Economy, were major events over the first half of the year which helped to turn sentiment around. 

More rate cuts by many central banks and expansion of quantitative easing, with the Fed purchasing $300 billion in Treasuries, and the ECB unveiling a EUR 60 billion covered bond purchase plan, provided a further boost to recovery efforts. This was coupled with the passage of US bank stress tests which at least gave some transparency on the state of US banks’ balance sheets. 

These efforts appear to be paying off as confidence has improved, data releases especially in Q2 09 have revealed a much smaller pace of deterioration, whilst some US banks felt confident enough to pay back TARP funds, marking a turning point for the US financial sector. 

Markets reacted to all of this news positively once it became clear that a systemic crisis had been avoided; most US and European indices, with the notable exception of the Dow ended H1 2009 with positive returns.  However, their gains were less impressive when compared to the strong gains in some emerging equity markets, with indices in China and India registering gains above 50% this year as recovery efforts in emerging markets echoed those in the G10, but with the advantage of far less severe banking sector problems.  

Currency markets have also given up the high volatility seen at the start of the year as many currencies have now settled into well worn ranges.  Measures of equity market volatility have also swung sharply over H1 2009, with the VIX index now less than half of its 20 January peak. Other measures of market stress have undergone significant improvement, with much of this taking place in Q2.   For instance, the Libor-OIS spread dropped to its lowest level since the beginning of 2008 and after peaking at close to 450bps in October 2008, the Ted spread has now dropped to a level last seen in late 2007.  The change in market sentiment over H1 was truly dramatic but there is little or no chance that this will continue in H2 2009 as I will explain in my next post.

Posted in Asia, bank rescue, central banks, China, Currencies, Economics, Economy, equity markets, Europe, Financial crisis, India, US. Tags: , , , , , , , , , , , , , , . 1 Comment »

Is the Asian FX rally losing steam?

June 5, 2009 — Mitul Kotecha

Asian currencies appear to have lost some of their upward momentum over recent days.  Although the outlook remains positive further out, they are likely to struggle to make further gains over coming weeks.  One the one hand strong inflows into Asian equity markets have given support to currencies but on the other hand, data releases reveal only a gradual economic recovery is taking place, with continued pressure on the trade front as seen in the weakness in recent export data in the region.  Even China has been cautious about the prospects of recovery in the country.   

Almost all currencies in Asia have recouped their losses against the US dollar so far this year, with the Indonesian rupiah the star performer, having strengthened by over 11% since the start of the year.  More recently the Indian rupee has taken up the mantle of best performer, strengthening sharply following the positive outcome of recent elections.  The rupee has strengthened by around 3.5% since the beginning of the year and its appreciation has accelerated post elections.   

Much of the gain in the rupee can be attributable to the $4.4 billion of inflows into local equity markets over the last few months, a far superior performance to last year when India registered persistent outflows. Notably in this respect, the Philippines peso is set to struggle as foreign flows into local equities lag far behind other countries in the region.  Inflows into Phililipines stocks have been just $226 million year-to-date as fiscal concerns weigh on foreign investor sentiment.   

South Korea has been the clear winner in terms of equity capital inflows in 2009, with over $6 billion of foreign money entering into the Korean stock market.  Elsewhere, Taiwan has benefited from the prospects of growing investment flows from China and in turn equity market inflows have risen to around $4.3 billion supported by news such as the recent report  that Taiwan will allow mainland Chinese investors to invest in 100 industries.  Equity inflows into these currencies are far stronger than over the same period in 2008, highlighting the massive shift in sentiment towards Asia and emerging markets in general.

Unsurprisingly stock markets in Asia have been highly correlated with regional currencies over recent months, with almost all currencies in Asia registering a strong directional relationship with their respective equity markets.  Recent strong gains in equities have boosted currencies but this relationship reveals the vulnerability of currencies in the region to any set back in equities, which I believe could come from a reassessment of the market’s bullish expectations for Asian recovery.  

Central banks in the region have been acting to prevent a further rapid strengthening in Asian currencies by intervening in FX markets but a turn in equity markets and/or risk appetite could do the job for them and result in a quick shift in sentiment away from regional currencies. The Indonesian rupiah remains one to watch in terms of further upside potential, supported by the Asian Development Bank’s $1bn loan to Indonesia.   The outlook for the Indian rupee also looks favourable as post election euphoria continues.  Nonetheless, the gains in these and other Asian currencies have been significant and rapid and I believe there is scope for a pull back or at least consolidation in the weeks ahead.

Posted in Asia, central banks, China, Currencies, Economics, Economy, equity markets, India, Indian election. Tags: , , , , , , , , , , , , , , , , , , , . 1 Comment »

Backing the dollar

June 3, 2009 — Mitul Kotecha

There has been no let up in the bullish tone to markets over recent weeks. Optimism is dominating. Meanwhile, commodity prices continue to remain firmly supported, with the CRB commodities index up around 30% from its early March low. Bank funding has improved sharply, with indicators such as the Libor-OIS spread moving to its lowest spread since the beginning of February 2008 whilst the Ted spread is now close to where it was all the way back in August 2007.

Conversely, there is not much sign of a let up in pressure on the dollar despite assurances from US Treasury Secretary Geithner during his visit to China. Much of the move in the dollar continues to be driven by improvements in risk appetite but worries about the sustainability of foreign buying of US assets have increased too.

Russia’s proposal to create a new supranational currency has dealt the dollar another blow but it was notable that India, China and South Korea were reported to express confidence in the dollar, stating that there is no alternative to the dollar as a reserve currency. Such comments highlight that despite political motivation to move away from the dollar it is no easy process.

The comments from India, China and South Korea, three of the world’s biggest reserve holders reflect the growing concerns from official accounts about 1) dollar weakness getting out of control and 2) US bond yields pushing higher. Even though foreign central banks will continue to diversify the last thing they want to do is to destroy the value of their massive amounts of US asset holdings so don’t expect a quick move out of dollars from central banks despite the rhetoric from Russia and others.

Russia has said that a debate about the dominance of the USD will take place when BRIC (Brazil, Russia, India and China) countries meet on June 16. Although the rhetoric from Russia may add to dollar worries the reality is that it is highly unlikely that any form of concrete plan will be easily developed to shift away from the dollar. Political motivations aside, even Russian President Medvedev admits it’s an “idea for the future”.

Posted in Bond markets, central banks, China, Commodities, Currencies, Financial crisis, India, US. Tags: , , , , , , , , , , , , , , , . 1 Comment »

Will India remain in the shadows?

May 18, 2009 — Mitul Kotecha

Indian markets rejoiced in a big way following the outcome of the elections which put the secular Congress party back into power as the head of the United Progressive Alliance.   Stocks in India rose by a massive 17% and the rupee strengthened as markets gave a huge thumbs up to the outcome.   The margin of victory was bigger than had been expected and allows Congress to form a government with only minimal help from outside parties.  

Given that many had feared that the election would result in another unstable coalition supported by diverse parties each acting in their own interests,  the outcome was very positive.  In the event the result provides Congress with a strong mandate for change and reform.  The real question is whether they will grasp the opportunity or let it slip by and fall further behind into the shadow of China. 

There are of course many challenges that need to be faced on the home front including the alleviation of poverty for a huge chunk of the population, improving education, access to health care etc.   India also needs to move ahead with infrastructure spending, something which remains key to unlocking India’s potential growth and moving towards the pace of growth achieved by China.    As a comparison India spends around 6% of GDP on infrastructure spending compared to around 15% in China.   The results of such spending are obvious when looking at the pace of growth of both countries, with India growing relatively more slowly than China.

The issue is that even if the government has the mandate and the will to move forward with long awaited spending on infrastrucure, finding the money is the main problem.   The Indian government identified the need for $500 billion in infrastructure spending between 2007 and 2012 but the global financial crisis has seen a lot of potential investment disappear as banks bec0me increasingly strapped for cash and foreign investment shrinks due to lack of funding and an aversion to risk.   Restrictions on investments by funds that could potentially invest have also not helped whilst the government is limited in its spending by a huge fiscal deficit.    

The Congress party will need to grasp the opportunity that the election result has brought it and move forward to entice the investment needed to push forward with infrastructure plans.   One of the benefits of India’s slow pace of reform and gradual opening up of the economy is that the country has avoided the worst of the global economic crisis.  Even China will find it a huge challenge to shift its growth engine from export orientated growth to domestic consumption.  India is in a good position to take advantage of its relative resilience and now has a government with a strong mandate to do so.    It would be a great pity for India and the rest of the world, given the potential for the country to become a much stronger trading power, if the government did not take this opportunity by the horns once the celebrations are over.   If not, the rally in Indian markets may prove to have been a fleeting one.

Posted in Asia, China, Currencies, Economics, Economy, equity markets, Financial crisis, India, Indian election, Politics. Tags: , , , , , , , , , , , . Leave a Comment »
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