How are the Indian and global economic environments affecting the financial markets?
This week we also present an analysis of the US economy because of some concerns about whether the US economy has peaked and if there could be a recession in the world’s largest economy which could affect the rest of the global economy due to exposure to the US and especially given the start of the trade war, in particular, between the US and China.
- Both Federal Reserve Bank of Atlanta and Federal Reserve Bank of New York produce what are known as Nowcasts of the US economy, in real time, as data becomes available. These Nowcasts show a strong economy with the second quarter from April-June 2018 being particularly strong in the range of annualized GDP expansion of 2.8-4 per cent. This growth has been accompanied by continued strong employment numbers with muted wage increases thereby assuaging concerns about wage increases passing through to inflation. The Fed-preferred US inflation measure is currently at the central bank’s target of 2 per cent and the Fed is on the path of gradual rate increases as expected by the markets.
- Growth has been buttressing any downside effects of the US trade war with its major trading partners China, the EU, Canada and Mexico which, on net, is providing positive global cues. As a result, Indian financial markets reacted positively to upward movement in the US markets after the recent strong US employment data. The effects of the trade war on the US economy will not be known until after the third quarter of 2018 depending on the level of escalation of tit-for-tat tariffs between US and China and other non-tariff barriers China might erect against US companies doing business in China.
- Some observers are looking at the narrowing spreads between short term and long term US treasury bonds and becoming concerned that the flattening of the yield curve, especially given the age of the current US economic expansion, could mean an eventual yield curve inversion with short term yields rising above long term yields signaling the prospect of a recession in 6-18 months after the inversion. US bonds are a safe haven asset and the flattening is the result of the rising short term rates, albeit gradually. The yield curve, despite the narrowing spreads between the short and long bonds, shows no signs of inverting and it is a fallacy to think that economic expansions age and die. It depends on government policies and domestic demand in the US and both monetary and fiscal policies are now conducive to continued growth. Should the trade war escalate further, the US economy could adjust to the new reality through import substitution while still not slowing down into a recession. The trade war, if fully escalated with no resolution, will adjust global supply chains to avoid tariffs. In fact, it could boost US economic growth because of trade war-induced higher domestic investment to cater to domestic demand even as some US companies shift production to other countries to avoid tariffs on imports from the US by those countries of the US companies’ goods.
- Foreign portfolio and institutional investors (FPIs and FIIs) are repatriating their dollars due to concerns about Indian macros, pressuring Indian forex reserves, the rupee and the equity markets. Home bias, on net, however, is supporting Indian equity markets with domestic funds investing in them and therefore, there is a net flow of capital into the Indian equity markets countering the selling pressure.
- CPI inflation for India is at 5% in June and IIP is at 3.2% in May. Both of these numbers are not encouraging because industrial production slowed while inflation rose. The inflation data points to at least another rate hike by the RBI this year, pressuring GDP and the Indian financial markets.
What to expect from the markets next week?
The equity markets in India and in other major economies are expected to remain stable and react to the second quarter earnings reports against the backdrop of the oil price and the trade war. Oil price may move in a range-bound manner between USD 70-80/barrel, falling due to the trade war and rising due to market tightness amid global growth. The other commodity markets will move based on, among other factors, how the Chinese economy is adjusting to the trade war.