Moneycontrol
Feb 17, 2017 04:37 PM IST | Source: Moneycontrol.com

COMMENT: Markets would do well to heed RBI governor Patel

RBI governor Urjit Patel, in an interview with Network 18 Group Editor-in-Chief Rahul Joshi, highlighted the strength of the Indian economy and the prospects of the country post demonetisation.



RBI Governor Urjit Patel, in an interview with Network 18 Group Editor-in-Chief Rahul Joshi, highlighted the strength of the Indian economy and the prospects of the country post demonetisation. Though the governor presented a strong case for the Indian economy based on domestic issues, his hesitation was prominent when it came to global issues, especially the impact of US President Donald Trump’s actions.


On US policies under Trump Patel emphasized that ‘…one issue that people are not realizing is that there will be a reaction to what the US does. That could get messy.’ Patel is right when he says that people, especially in equity markets, are not realizing the impact of US protectionism. 


The Morgan Stanley Capital International (MSCI) All Country World Index, which includes markets in 46 countries, touched a record high on Wednesday. Strength of the market can be judged from the fact that world equity markets have been buoyant despite a series of negative events taking place globally. Since the beginning of February world markets are in synch and have been steadily rising.


Markets have shrugged off Brexit, the rate increase by the US Fed and any suggestion from experts that money will be diverted from equities to debt. The surprise US election victory by Donald Trump also saw only an intra-day knee jerk reaction as markets regained their move higher.


Technical analysts have given a call that markets at current levels in an overbought level and one needs to be cautious of the rally going forward. Fundamental analysts too are not comfortable with valuations. However, history is witness that caution has few takers in a bull market rally, especially in a liquidity-infused rally such as the one we find now. Financial markets by their very nature discount the future so it seems that future rate hikes by the US Fed are also in the price.


More than political and monetary measures taken by central bank, the underlying current that seems to be deciding the trend in the market is crude oil. Over the last two years the correlation between the two markets has been strong, especially since the time when oil prices fell below the USD 40 mark.


 
The sharp fall in oil prices this month saw oil producing companies sell financial assets in the world market thereby pulling the indices lower. But as the oil market stabilised so did financial markets. Renewal of a cartel by oil producing countries saw more stability in oil markets, thus giving a further boost to equities.


Here is where Trump’s protectionist policies will have a severe impact. Trump has promised to boost the US fossil fuel industry and create more jobs. Higher shale oil and gas output from the US has hit the oil market earlier and has a strong probability of doing the same again.

During the previous fall in oil prices oil producing countries sold financial assets in emerging markets but held on to their US bonds. There is no guarantee that they might do the same if Trump plays the protectionist. This could trigger the trade war that Patel has warned of. World markets would do well to take heed of what Patel is saying.

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