Theresa May announces her decision to step down
Change in leadership holds hope for resolving the deadlock
Renewed US-China trade war continues to be the key global risk
US yield inverts again; trade war & low inflation point to rate cuts
EMs may benefit as the global central banks may increase accommodation
India can possibly stand out with stable polity & prospects for strong policy measures
After a tumultuous turn of events, UK Prime Minister Theresa May has announced her decision to step down, deepening the Brexit crisis. Lack of consensus in her own party was visible with respect to the Brexit Bill likely to be introduced on May 24 – her fourth such attempt.
This had a rub-off effect on financial assets – the pound sterling depreciated sharply against the dollar from 1.31 levels, which has also been a technical resistance level for nearly past one year. The currency volatility is substantially lower than the few weeks before as a lenient European Union had pushed back the Brexit deadline to October 31, 2019.
In the near term, this adds to global uncertainty though a change in leadership or a possible election holds hope for resolving the deadlock.
But a renewed US-China trade war remains the key global headwind. What is adding to the worries is a worsening growth slowdown, which has impacted the US yield curve. One can sense the anxiety with a sudden drop in oil prices on Thursday. Investors are keeping an eye on the crude supply shortage after US sanctions against Iran and Venezuela disruptions are expected to be supportive of prices.
The US yield curve (10-year - 3 month) inverted and was in the long end, which is hovering at around 2.33 percent. And there is a clamour building for a more accommodative policy. FOMC member and Chair of Federal Reserve Bank of St Louis James Bullard said it as much, as he spoke of a case for rate cut, given subdued inflation.
Interestingly, the CME Fedwatch tool sees 42 percent probability for a rate cut by the year-end.
Overall, we maintain that the intensifying trade stand-off can weigh on the fragile growth in other parts of the world such as Europe.
Also, we may see more attempts from individual central banks, including RBI, to keep an accommodative stance. In the case of India, the upcoming monetary review meet on June 6 is a key event to track. The central bank has its task cut out as the global interest rate cycle is buffeted by growth challenges and subdued commodity inflation.
An accommodative interest rate environment means institutional money may find favour in select emerging markets where domestic economy is on the mend in a scenario of growth moderation -- and not recession. Even smart money will be looking at EMs where the real interest rate differential is high.
For India, a strong political mandate for the incumbent government in the just-concluded general elections offers a context for stable polity. There are high prospects of strong reforms in the near term even though there are considerable challenges on the fiscal side.
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