The lack of a QE3 (Quantative Easing) announcement by the US Federal Reserve (Fed) led to large scale risk aversion trades by investors globally. Equities fell, commodities fell, US treasury yields fell and the US Dollar (USD) gained. Equity indices fell anywhere between 4% and 9% across the globe while the Reuters CRB commodity index fell 8% week on week. Ten year benchmark US treasury yield fell to record lows of 1.72% last week while the USD index gained by close to 2.5%. The question is will this trend continue or will something come up on the horizon to change the trend?
Markets took a bit of hope from the G20 nations pledge to rein in the global economic crisis with equities and currencies’ coming off from lows on Friday the 23rd of September. However given that each of the G20 nations has its own issues, there is limited scope for concerted action. US are facing debt ceiling issues, Europe is facing debt default issues, emerging economies are facing inflation issues and the whole world is facing a slower growth threat.
Corporate results can help in containing the sell off. However a sluggish economy in the US and Europe and emerging economies including India and China tightening policies to contain rising inflation expectations, outlook for corporate profitability is not very positive.
There could be some relief if there are indications from central banks in India, China, Brazil, Korea and other developing nations that interest rates have peaked and there is scope for rates coming off down the line. Lower rates in these countries can increase aggregate demand leading to a cushioning of the fall in growth expectations. However low rates are still some time away and given currency volatility many central banks will prefer to keep rates high to prevent further volatility.
In the meanwhile, the ride is going to be rough.
Indian markets saw large cap indices fall by over 4% with Nifty option implied volatility move up by 17%. This week is the September derivative contract expiry week and there is a good possibility that markets will prefer to close out short positions rather than let it roll over. Shorts being closed out in the expiry will lead to stability in the indices at lower levels.