Published on 17/12/2018 4:13:09 PM | Source: Yes Securities Ltd

INR – Worst is behind us - Yes Securities

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INR – Worst is behind us

Indian Rupee regained significant ground during November, with values rebounding from a low of 74 to trade towards 70. Emerging consensus of lower trajectory in oil and softening sovereign yields pose as a substantial tailwind for emerging markets, reflected by resumption of foreign capital inflows. Meanwhile, a trade truce between US and China has also soothed nerves and the thaw is expected to stay for some time given the renewed inclination of Beijing and Washington to avert a long-lasting destabilizing impact on the global economy. US flattening yield curve can also be deemed positive for emerging market currencies as an impending slowdown in the US economy can hard-press Fed to pause or probably reverse the monetary tightening process. We see US dollar index being vulnerable to a probable Fed policy “reset”. On INR, we sense that most of the pain is already factored in, with the currency expected to trade on a relatively stable note. We remain neutral on the Rupee going into next 2-3 months, with values seen trading in the range of 69.5-73. 


Bonds don’t lie – Flatter Yield Curve hints at a Fed pause in 2019

Although a Fed rate hike this month is a writing on the wall, it is discounted by the markets and emphasis is on whether the Federal Reserve will be committed to the policy normalization initiative going forward. In this regard, flattening yield curve between US10yr and 2yr sovereign bonds sketch a divergent picture. In fact, there is a genuine risk of the yield curve inverting in next few months.

The longer end of the curve is not proportionally reflecting prospects of persistent rise in interest rates, with the 10yr yields peaking around 3%. It seems credit markets are factoring that slower economic growth in US next year would eventually compel the central bank to adopt a pause on interest rates. There is a growing consensus that Fed will realign its next communiqué signaling that markets should prepare for a relatively dovish stance from the bank going into 2019. Experts reckon that there will be one rate hike at most next year, with credit markets assigning only 25% probability of a second move. The third-rate hike is completely ruled out, a fly in the face of earlier dot plot projections. Although US consumer spending remain strong, other sectors like housing, autos and business investment are already showing signs of deceleration. To wit, fourth-quarter GDP is now projected around 2.5%, 1% lower than Q3. Fed is certainly concerned about slowing global macro backdrop, gloomy trade scenario and fragile financial markets. This can also be corroborated by Fed projections of slower GDP expansion for 2019 and 2020. 


Persistent Policy norm peters out growth

Going by historical data, economic deceleration in US is invariably caused by an aggressive monetary policy tightening. For instance, interest rates were hiked to 18% in 1980 from 6% in 1976, which caused a noticeable drop in GDP growth from 5.4% in 1976 to 0.2% in 1980. The Alan Greenspan era is also reminiscent of the same phenomenon, when borrowing costs were ratcheted to 5.25% from the low of 1%, resulting in a recession in 2008 and 2009. With Fed rates projected to reach 3.1% in 2019 and 3.4% in 2020, a tacit risk of growth fading cannot be ruled out. Law of averages for seven decades suggest that growth cycle in US on an average stay put for 32-35 quarters, before recession sets in. The current expansion cycle is already long in the tooth, lasting 35 quarters, beginning from 2010. Although we do not see a risk of recession, a lower growth trajectory in the next few years seems probable.


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