Will the flight to safety reverse?
Flight to safe haven assets characterized July trading. Gold and US treasuries performed while equity markets fell. In the currency markets the Japanese Yen was the best performer. August should see some reversal of trends if the factors that moved markets in July plays out on a positive note.
On the domestic front inflation, rate hikes, scams and corporate results took center stage. Sensex and Nifty fell and bond yields rose while the Indian rupee (INR) gained over the month. Inflation as measured by the WPI (Wholesale Price Index) rose to 9.44% in June from 9.06% in May. RBI estimates inflation will stay at higher levels till December 2011 before coming off. The RBI raised the benchmark policy rate the repo rate for the third consecutive month in its July policy review. The higher than expected 50bps rate hike helped push up bond yields and bring down equities. Corporate results showed topline growth while the bottom line was hit by inflation and interest rates. Topline on an average for the Nifty companies has grown by over 20% while margins have come off by around 200bps. Tight monetary policy and prospects of inflation remaining sticky at higher levels is hurting investments. RBI has highlighted the declining corporate investment trajectory in its policy review in July.
The 2G scam investigations are continuing with more revelations by those accused. The mining scam in Karnataka is hurting corporates, which are involved, and the ban on mining will restrict raw material supply to steel producers. On the whole, Indian markets look set for a rough ride on the back of all the factors highlighted above but things could turn if there are positives coming out of inflation and interest rates, which look to be peaking out.
On the positive side FII’s have turned net buyers in June and July and have bought close to USD 2 billion of equities. FII’s were net sellers till June on a calendar year to date basis and their purchases in June and July have turned them net buyers.
Global markets reeled on the back of many issues. The first was China inflation and ability of China’s banks to cope with defaults of local governments. The second was the Eurozone debt issue, which threatened to go out of control with a default by Greece on its debt. The third was the US debt ceiling issue where an agreement is yet to be reached on raising the debt limit for the US. China issues remain and if China’s growth slows down commodity prices will react which is positive for India and global inflation. The Eurozone countries have resolved the Greece issue temporarily while the US debt ceiling is unresolved. Global markets will see choppy trading on the back of the macro issues.
On a year on year basis developed equity markets have outperformed as emerging markets fought rising inflation. US bond yields have come off by 12bps year on year while Indian bond yields have risen by 65ps indicating the inflation issue. If the trend of inflation and interest rates reverse emerging markets could try and catch up with developed market performance