Anindya Banerjee Currency Derivatives Researcher, Kotak Securities
Indian Rupee witnessed one of the most volatile moves during the first quarter of 2016 or final quarter of FY16. Rupee moved between 4-6% against major currencies if one considers December 31st close and first quarter highs and lows. Volatility was exceptionally high across asset classes and currencies as central banks intervened to backstop bleeding risk appetite. It was first Bank of Japan who announced negative interest rates, followed by the European Central Banks who not only reduced deposit rates further into negative territory but also greatly expanded its asset purchase program. US Federal Reserve was not to be left behind as they followed up with very dovish rhetoric which pushed the interest rate hike expectation to mid of next year.
Interestingly all these happened either going into the G-20 meeting in February in China or after that. As if an unofficial truce was declared between major central banks engaged in the currency and the agreement was on the need to move away from the game of competitive policies towards co-ordinated policy framework. Back home, sentiment took a 180 degree reversal post Budget. Any seasoned observer of the market will find the behavior of investor high unstable and dangerous. Going into the Union Budget, investors were gripped in irrational fear; as a result Indian assets were diverging negatively from the world markets. Having priced the Armageddon, post Budget, there was only one way to go, and that was up for the Indian Rupee and the Indian financial asset prices. Foreign investors who had suddenly caught flu towards Indian markets in January and February, was falling over each other to scoop up the same asset at higher prices. We understand that is how sentiments shift but what is shocking is the magnitude of the shift in sentiment over just 90 days. Sentiment moved from neutral to abject fear from December of last year to February of this year and then back to euphoria in just 31 days of March. Forget fundamental, even technical structures do not change in such a short span of time. It is clear case of massive herding in investment, which is alarming.
We have to zoom out of the daily noise of markets to be able to see the big picture. The question we need to ask is why financial markets are getting stressed to often now. They are being saved every time by constant attempt my central banks and policy makers to dominate the narrative. It is a narrative driven financial markets, where there is lack of faith over fundamental drivers and greater addictions towards a fresh narrative from the policy makers. Post 2008, how much of the discussion veers around what central banks can do and will do, rather than anything else. Such a talk has become the top agenda for discussion for retail investors as well as for every kind of institutional investor. Something has definitely gone wrong, when investment has come to punting on central banks. We do not think central bankers too would have imagined it would come to this moment. Policy makers have become like the daredevil stuntman of a circus, where unless he or she ensures more extreme, insane and perilous acts every other time, the audience, in this case asset managers, will become disappointed and desert the risk assets in a herd like fashion.
Stage one saw the debt crises causing debt levels to level off and then slowly roll over. Peak in private debt meant, consumers started to reduce their levels of consumption. It was followed by stage two, which was about the adverse impact on income flows, caused by falling current account balances. Consumers reduced their consumption, which meant lower current account deficits in the consuming nations. Someone’s consumption is someone else’s income, so producer nations saw their current account surpluses contract. In stage two something interesting happened, central banks having studied the previous similar cycle which played out during the 1930s, jumped into the ring to protect the financial institutions and prop up asset prices.
Investors need to account for the narrative driven market structure in into their wealth management plan. As managers of financial risk:- 1) foreign exchange 2) interest rates we need to factor the implications of the new era. We will have to embrace the fact that we will sudden burst of massive volatilities in rates and fx and also emergence of some strange cross asset and cross currency correlation. It is no longer the simple world, where a rising dollar meant short risk and falling dollar meant long risk.
Managing that risk in Indian Rupee would mean that we can expect central bank to play a key role in ensuring Rupee remains within a wide range against the US Dollar. RBI has already made it quite clear that it will pursue purchase of domestic bonds and also foreign currencies to shore up Rupee liquidity. It is a strong signal that Rupee may not be allowed to trend too much against the US Dollar. Hence, we see a range of 66.00 to 68.00 over the April-June quarter and 66.20 to 67.20 over the next few weeks. However, Rupee may continue to trade weak against non-dollar currencies like Japanese Yen and Euro but remain firm against British Pound. Indian long tenor bonds are expected to remain firm as 10 year yields are expected to remain between 7.30 to 7.60 over the medium term.