Greece bailout or policy easing in India and China can ease selling pressure
Financial markets will go into October looking for reasons for trend reversals. The reason could arise from a managed bailout of Greece or from prospects of monetary policy easing in China and India. The primary worry for markets is the Greek contagion spreading into other Eurozone nations and the fact that major emerging economies of India and China are maintaining tight monetary policy despite threats to economic growth. The worries on debt and global growth is driving up the US Dollar and bringing down everything else in its wake. The USD index strengthened by 6% over the month of September as the US Federal Reserve (Fed) opted to maintain its balance sheet size rather than increase it. The Fed announce “Operation Twist” for USD 400 billion where it will replace short dated bonds with long dated ones. Operation twist led to a 25bps fall in the benchmark ten year US treasury.
The German parliament voted for Germany to increase the size of the bailout fund, the European Financial Stability Facility (EFSF), which will be used to support debt ridden nations such as Greece, Ireland, Portugal, Italy and Spain. The immediate threat is that of Greece defaulting on its debt, which if managed properly will provide comfort for markets. A more concerted effort by the European Union and the ECB to stave off debt threats in the Eurozone will be positive for markets. The weakness in the Euro, which has fallen by 7.2% over the month of September, indicates that markets are still cool to the idea of a properly managed bailout plan.
Inflation threats are still high in emerging market countries including Brazil, India and China. August inflation numbers for all these countries came in on the higher side at 7.23%, 9.78% and 6.2% respectively. Central bank actions differed with Brazil cutting policy rates and India raising policy rates. The markets are expecting Brazil to cut rates further in the wake of threats to growth due to commodity market weakness. Brazil is a commodity driven economy with its main equity market index, Bovespa, weighted 50% towards commodities. The fall of over 10% in the Reuters CRB basket of 19 commodities is threatening commodity exports of Brazil.
The RBI on the other hand raised policy rates in September in the face of inflation trending at higher than expected levels of 9.78%. Inflation in India is yet to show signs of cooling off forcing the RBI to maintain a tight policy regime. China’s inflation is still seen as a threat to economic stability, with inflation at 6.2% close to multi year highs of 6.4% seen in July 2011. China monetary policy is still on a price stability mode, though markets are factoring in policy rates remaining stable at current levels.
The prospects of India and China easing rates down the line are bright with the current weakness in economic growth globally feeding into commodity prices. US GDP growth forecast for 2011 has been revised by 100bps by various think tanks, while the Eurozone is expected to fall into recession in 2012. Weak global economic growth will feed into growth rates coming off in emerging economies including India and China. Markets can look up if People’s Bank of China and Reserve Bank of Indi indicate policy rates easing down the line.