Global raw material prices are on a wild tear—copper is approaching its all-time high north of USD 10,000, aluminum and steel prices are rising every day, and petroleum based inputs are threatening to break through the top. All of this is, of course, driven by the rude health of the rapidly recovering US economy primarily as a result of its super-effective vaccination program. Again, the fact that the Fed and Treasury tag team seems to have everybody (in the US) with money to burn, is keeping the pot boiling over.
Interestingly, US bond yields and the 10-2 spread, which first signaled potential inflation in August of last year, have both retreated over the past month or so, suggesting that the market still believes that Powell will be able to manage the huge government borrowing requirement and maintain its high-level liquidity drip into the market without upsetting things. The equity markets are, of course, at all-time highs, enjoying the liquidity bath.
To be sure, there are gathering signs of excessive risk-taking in both equities and bonds – the spread on near-default grade corporate bonds is the lowest it has been since the 2008 crisis, a large number of SPACs (companies set up to enable weak companies to list) are well under water, and there have been several high-profile failures in the capital markets. But then markets can stay ”frothy”, as Powell recently commented, for years—recall that equities rose for 6 years after Greenspan’s “irrational exuberance” comment in 1994.
The dollar, of course, has been sliding since mid-2020, when several heavy-hitter analysts concluded that the huge stimulus the US economy required would send the dollar down, down, down. In parallel, a few months later, commodities started up, as did bond yields, as already mentioned. In the event, the dollar has held up pretty well—the DXY fell from a bit over 100 to a bit under 90, a far cry from the 25-35% declines that had been forecast at the time. Indeed, at the present time, DXY appears to be slowly climbing a jerky ladder. I think a dollar collapse, from these levels, is not coming.
The rupee, on the surface, appears to be playing its own game. Since the start of 2020, it has taken two major hits, each one triggered by the Coronavirus; in both cases, it felt like the bottom was about to fall out, bringing the 80-rupee-wallahs out cheering. However, in the interim, it was able to regain a reasonable amount of value, responding to dollar weakness, the generally enthusiastic global investment sentiment (at least till March 2020), and RBI’s huge pile of reserves that served to keep speculators off balance.
Despite the fact that investment sentiment deteriorated—a net outflow of $1.4 bn in April versus a net inflow of $1.8 bn in March—RBI was able to pick the rupee back up quickly from its sub-75 lows when it fell sharply in mid-April; this despite the fact that the second wave of the virus was spreading frighteningly. Not only that, RBI was able to beat back the NDF spread, which is a loud harbinger of sentiment, from well over 15 paise to a respectable 2-3 paise last week.
After the ruling party’s poor showing in the West Bengal elections over the weekend, the NDF spread has against jumped sharply and 1 month is at nearly 20 paise, indicating a sharp deterioration in sentiment. However, RBI has been able to keep the rupee from feeling the pain. The forward premiums have been rising, suggesting that much of the intervention has been in the forward market, as opposed to spot to avert a further increase of domestic liquidity. Given that the mix of state lockdowns (and a possible central one) are likely to impact supply chains again, and the soaring global raw material prices would both seriously affect domestic inflation, RBI needs to—and, we believe, will—pull out all the stops to prevent another sharp drop in the rupee.
Look for a continued choppy market (73.80 to 75.20), with RBI likely to be able to hold the line, unless, of course, the “Dante’s inferno” that we are suffering on the ground gets even worse and/or something gives in the global market.
Let us pray (and not just for the rupee).
CEO, Mecklai Financial