Equity rally on the cards
Equity markets are going into August 2012 with hopes of monetary easing working its way into economies. Weak economic data coupled with unsolved debt issues in the Eurozone is prompting central bankers to provide more monetary accommodation. ECB (European Central Bank) is expected to commence bond purchases and carry out a third round of LTRO (Long Term Refinance Operation) to prevent a collapse of the Euro. The US Federal Reserve is maintaining rates at close to zero per cent and is buying long term government bonds in place of short term government bonds (also known as operation twist) to shore up a flagging US economy. Bank of England has increased the size of its bond purchase program while central banks from Brazil to Australia are cutting rates in the face of weakening economic growth prospects.
Asian central banks have started monetary easing with China cutting policy rates in June and July 2012 while South Korea cut rates in July. India’s RBI cut rates in April 2012 and has been buying government bonds to shore up system liquidity, which is in deficit.
Economic data has been weak across the globe. US second quarter 2012 GDP growth came in at 1.5% against 1.8% growth seen in the first quarter. China’s second quarter GDP growth was at 7.6% against 8.1% seen in the first quarter. India’s fourth quarter 2011-12 GDP growth at 5.3% was the lowest in nine years. Eurozone manufacturing contracted for the sixth straight month in July. Japan is facing the effects of a strong Yen, which has climbed by 40% and 70% against the USD and Euro respectively over the last few years.
Bond yields across the globe are trading at record low levels. US ten year treasury yields touched record lows of 1.38% in July 2012 while ten year bond yields of Japan and Germany at 1.4% and 0.78% respectively are trading at close to record lows. Bond investors are running to safe haven bonds on worries of debt issues of indebted Eurozone nations. Spanish ten year bond yields touched record highs of 7.5% before coming down on the back of tough ECB talk on preventing an Euro collapse.
Indian ten year bond yields at 8.11% is down 40bps from highs seen in April 2012 but is 10bps up from lows seen in June 2012. Indian rates have been sticky at higher levels on slow policy easing action. Bond yields will trend down if RBI cuts rates going forward.
Euro fell over 2% month on month and has lost over 14% year on year against the USD as markets fretted over Greece and Spain. ECB bond purchases and a third LTRO will flood the Eurozone with liquidity leading to more weakness for the Euro. A weak Euro will help emerging currencies gain in strength and the Indian Rupee, which is down 25% year on year against the USD will slowly climb up.
Commodities came back from lows seen in June 2012 on the back of monetary easing expectations. The Reuters CRB index that tracks a basket of 19 commodities gained 10% month on month while Brent crude gained close to 15%. Commodities will find it difficult to maintain strong uptrends given weak economic growth.
