Fed not in favour of bulls; brace for volatility today

The Federal Reserve's crucial meeting on its monetary stimulus on Wednesday did not work out as the bulls would have hoped. Fed chairman Ben Bernanke said that by the end of this year, its quantitative easing (QE) will starts tapering. Hence, the fountain of liquidity that we have got used to over the last few years is slowly but surely drawing to a close says Udayan Mukherjee, managing editor CNBC-TV18.

This dip in liquidity will have great ramifications for the macro of various countries and certainly for implications on every asset class.

“Asset classes have reacted, emerging market (EM) currencies have fallen overnight, stock markets have fallen and the US bond yield which we track most closely, has shot up to 2.36 percent. So, things have moved completely in the wrong direction from what we may have expected or hoped to see. This morning it will cause some turbulence in India as well,” adds Mukherjee in an interview to CNBC-TV18.

Below is the edited transcript of Mukhejee’s analysis of the market.

Asset classes’ performance globally, is compounded by the fact that China has quietly slipped through a really awful purchasing managers' index (PMI) number. So, there is a bit of a growth scare in the region. Anyway, overnight the pretence for EM flows were not great and as if the case for EMs is not very strong in a relative world, China puts out a really ugly number this morning as well.

Everything that could have probably gone wrong over the last 24 hours or 12 hours has gone wrong and one can see the impact in various asset classes. So, what we will discuss over the next one hour is probably the immediate impact on the market, foreign institutional investors (FII) flows, how much stock markets and currencies will correct,  etc.

That is the short-term, but I think what Ben Bernanke probably indicated yesterday has much deeper ramifications for several countries particularly countries which are running large current account deficits (CAD). So, once we are done with the adjustments of the next couple of days where stocks and currencies will react to what was said overnight and they may fall somewhat and then recover, but that is all in the realm of the short-term.

In the medium-term I think a lot of reassessment is required because something fundamental is beginning to change around in the perception of liquidity and in the real liquidity in the global financial space. That is something that we cannot wish away. So, I think it requires a different kind of thinking right now. Whether the tapeing off will be in September or December is not that material. The notice has been served, whether it is four months or six months and the markets will now start to price in what this lower liquidity means and which counties do well from here and which countries do not from every asset class perspective. So, I think the events overnight and not just a short-term kind of a market trigger could have medium term ramifications as well and very important ramifications.

Ben Bernanke in cutting down or laying out his liquidity projection indicated that the US will grow between 3 percent and 3.5 percent in 2014. Now one can ask if liquidity indeed is going to come down over the next six-twelve months, what is that reduced liquidity is going to go into. Is it going to go into an improving US market which is where the liquidity is being generated? Will it even go into Japan where after this correction is done, people might figure out that growth is still on the uptick or will it grow into China, which is now expected to grow no more than or less than 7.5 percent even next year or in a market like India where we are dealing with large deficits and where growth is still bottoming out at 4.85 percent.

Hence, in a relative game, the case for developed markets still looks quite strong and that is the big problem that we have to grapple with now, that maybe over the last couple of years, some of our wrinkles got covered up because of this wall of liquidity, but now if liquidity starts to diminish, then some of those warts will get exposed, take India for example.

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We got very lucky over the last couple of years running this kind of a large deficit and with growth faltering like it did but the rupee did not suffer too much and the stock market did not suffer too much because there was always liquidity to support it.

Now, what will feed this current account deficit (CAD) if global liquidity is going to shrink? I think from a macro perspective and not just a limited stock market perspective, this question of enhancing both our asset classes, which is the stock market as also the big macro hole that we are running becomes a question of paramount importance. So, in the near-term what we will probably see is the trend of foreign institutional investors (FIIs) outflows continuing and sustaining. People will now have to get used to it and if the rupee goes for a toss which looks quite likely this morning and in the next few days then that might have repercussions on the FII holdings in the bond markets once again.

It is a vicious kind of a cycle that we may be walking into. I do not know what this will do to the rupee and stock market over the next few days. We may fall and then not fall too much. All that is fine, but in a medium-term to start to get used to living with outflows is something that we have not done for the last two-three years and that is a big change that we have got to adjust to.

On Nifty

One thing traders will conclude this morning is that the pullback has been aborted. We went to 5,700-5,680 and we pulled back to about 5,850. Today or this morning might mark the end of that pullback. So, where we will go and stop is difficult to predict. We may go to 5,750 or we may revisit the level of 5,700 or 5,680 over the next day or two.

Sometimes, the reactions to global events can be quite volatile. We have seen a fall, maybe after a couple of days, the markets will stabilise, there will be more assessment about what Bernanke said, some may even come to the conclusion that maybe for the next four-five months we are okay, so the market should not panic immediately.

A to and fro movement can happen. So, we may go down and retest that level, maybe find some support again there. These are possibilities, so the near-term is difficult to predict but the whole trade that one was talking about of getting to 5,950-6,000 on the back of a good outcome to this event, has been negated and now the best that the market will try to do is to form a range once again with the recent low as a floor. Maybe 5,850-5,900 could be a top and we may spend some more time consolidating in this range because if we do consolidate in this range, the conviction in 5,700 holding out for some reason in the near-term will grow.

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Though, in the medium-term it would appear that given the kind of macro headwinds, which we have at this point, the way the currencies are likely to move in the foreseeable future that holding out 5,700 in the medium-term will be a fairly challenging kind of a task. So, for the next couple of days, we may retest and try and forge a weekly closing around that level but in the medium-term have serious apprehensions of whether that level will hold out.

FII outflows

The current pullback seen in the market has not been backed by any kind of reversal in outflows from FIIs, which is that they started buying every time the market went higher. Market was going up, but FIIs were consistently on the sell side both in cash and futures. So, maybe in a sense they could see what was coming or maybe it has to do with the rupee.

It is a difficult call on whether now having seen or read Ben Bernanke statement, outflows will increase over the next few days both in the stock market and also in the bond market if the rupee goes for a toss. So, I think in a medium-term, we basically have to tell ourselves the kind of huge gush of liquidity that we have seen over the last eighteen months may just be a thing of the past. That does not mean that every month we will see USD 4-5 billion of outflows, but that means that we will not see USD 3 billion of inflows every month as we had sort of taken for granted. That is bad enough for Indian equities.

In a situation where technically this market is so heavily reliant on one entity which is the FII, he does not need to sell. Even if he stops buying, that itself will lead the force of macro gravity pull stocks lower. So, I think something fundamental is altering in the liquidity landscape and for India which is fed simply by one buyer - the foreign investor - this is deep ramifications.

On rupee performance

Currencies have reacted overnight. The Mexican peso is down nearly three percent, the Brazilian real is down two percent, and so is the South African rand. So, other emerging market currencies or peer currencies have already made their move overnight. Hence, in the next couple of days, there is a genuine chance of the rupee getting to that level of 60 against the the dollar.

Today, we will get pretty close to that and over the next couple of days if global sentiment does not improve or there is not some great rearguard action from the Reserve Bank, we will probably see 60 to the dollar.

The bigger question is, if the general global perception of what finances the Indian current account deficit (CAD) actually changes for the worse, then we have to ask ourselves whether 60 it is or if the rupee could depreciate further because people will legitimately ask what feeds the Indian CAD now.

The overnight events do not just impact Indian micro in terms of stock market impact, but it also has grave ramifications for macro and if the government is watching, I hope they are not in denial by coming out and making statements like Ben Bernanke statement has been misconstrued. They have to realise now that if India does not get its growth back, then its CAD will not be funded. They can have as many media conferences, they can have as many road shows, people just buy one thing and that is growth.

Hence, India’s only hope right now is to demonstrate that we can start growing at a faster pace and if that happens in a relative light, then we will attract flows and if we do not prove that in relative light, then we look poor and we will not get flows, our CAD will not get funded and therefore the rupee will continue to depreciate. So, if the government understands the seriousness of what happened overnight they will just throw hook, line and sinker towards restoring growth in the economy and not treat it like a test match, but like a 20-20 match now.