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Since November, 2008 the Federal Reserve began its QE program but since then no major recovery has been seen in the benchmark growth number of US. After a debacle in 2008, major economies across the globe have adopted various monetary stimulus instruments. Major economies including the US, Europe, Japan and China all have adapted to various monetary and fiscal stimulus instruments to support their respective ailing economy. Cheap money has led to rally in equities from emerging to developed economies and is quite evitable from the chart.
The recent developments in the world economy have become complex and economic shocks from China to the most recent Brexit are of greater concern that could hurt global growth. Traditional policy tools have already been used and financial resources have been depleted and strategist or economists need to figure out a way that could pull them out of the ‘QE’ trap. The recent G-20 meeting showed that the policy makers across the globe have shifted their focus from China to Europe after the surprise Brexit vote, a series of horrific terror attacks and threats of Italian banking crisis. In the recent past the PBoC had devalued the Yuan to levels of 6.70, lowest level since October, 2010 to support its exports which were lagging from quite some time. Fears of a China induced currency war and economic meltdown has left the host nation on the defensive as the policy makers continue to face questions about its currency policy. Another worrying factor for China is the subdued growth of metal exports that could worsen weak inflation problem that most central banks are grappling across the globe. PBoC has taken active steps to restore confidence, and pledged not to weaken its Yuan for competitive advantage.
Asian currencies have come under pressure because of the Yuan weakness but at the same time benefited as the Federal Reserve continues to delay its rate hike decision. At its latest policy meeting the Federal Reserve has hinted that the short term hiccups the US economy was facing has eluded. Hints of rate hike this year clearly shows that policy divergence between the Fed and the ECB will keep most market participants puzzled and also suggests that currency war raging across markets could enter into a more dangerous phase. Japan has been no different and, in line with expectation, expanded its stimulus by doubling purchases of ETFs, yielding to pressure from the government and financial markets for bolder action , but disappointed most market participants, who had set their hearts on more aggressive stimulus. The interest rate differential between risk free bond of the US and the German bunds has widened notably. Expectation has risen that sharp movements in interest rates and exchange rates can increase volatility in the markets, most notably for equities. High volatility will increase risk for some portfolios and they can be forced into reshuffling their positions. Most market participants are now worried that currency war impact could spill over interest rate markets. Central banks across the globe will be forced into accommodative monetary policies to avoid large capital inflows seeking higher returns. It has been observed in the past that a country lowers rates to weaken their currency to improve export competitiveness; there is a risk of capital flight, which may weaken the domestic economy. Yet if a country takes no action then the currency appreciates due to aggressive measures from competing nations, then exports suffer as competitors gain market share.
Looking at the ongoing currency volatility our view is that central bankers across the globe will remain on their toes. Central bank governors of major economies have shown concern over low inflation and fall in global crude oil prices will continue to keep inflation in check. US payroll number for August will be keenly watched as the Fed chair has hinted to raise rates as early as September. But our view is that the Fed would only consider raising rates in December as the central bank will have enough time to monitor economic data during this course. Until then the dollar against major crosses is expected to trade with positive bias and expect the Asian currency to trade with weaker bias. In the Asian pack, the rupee is expected to remain under pressure in August with average weakness of over 2%. The FCNR deposits impact is expected from September to November but the RBI has managed to build a sufficient amount of FX reserves which could restrict major depreciation for the rupee.