When should FED hike the rate in 2015?

Anyone remotely close to Forex market would know that the timing of US interest rate hike is the most analyzed event in last one year. The US dollar has been the best performing currency ever-since financial markets started to factor in US interest rate hike. To put things into perspective the US dollar index, which measures strength of US dollar against major currency pairs, has gained more than 21% in last 13 months. The US economic recovery has been modest, while other major economies continued to struggle against weak demand and low inflation. The labor market activity has been picking up steam with US unemployment claims falling to 42 year low levels and inflation has been showing modest recovery despite weak crude oil prices. These strong economic numbers allow the US Fed to ponder over interest rate hike, while Europe and Japan are yet to conclude their quantitative easing program me.

Ever Since October’2014 Fed meeting, where in FED finally concluded its bond buying program-me, market participants have been closely following FED meeting statements, meeting minutes and public speech of FOMC members for cues regarding the rate hike. The US Fed, who has bench-marked economic data as the main driver for rate hike, has evolved its stance on rate hike from ‘Considerable Time’ to ‘Patient’ and finally to ‘anytime lift off’.  Along the journey US dollar bulls have cheered every positive economic data pushing US dollar index above 100 levels. (The US Dollar index started in March 1973 at 100 level, soon after the dismantling of the Bretton Woods system)

This dream run of the US dollar was finally halted by so called transitory factors, which pushed US economy into temporary recession. Transitory factor such as unfavorable weather conditions, weak crude oil prices pushed the retail sales and core durable goods order into negative territory. Accordingly, the US FED revised the economic projection downward, but maintained that it will remain on a path of rate hike. The clouds over US interest rate hike deepened amid ongoing Chinese and Greece economic crisis. The US FED had acknowledged that it will remain mindful of the global economic condition before hiking the rates. From last few weeks the tide has again turned in favor of US dollar bulls as US economic recovery seems to have turned a corner. The US economy showed signs of strong recovery with core-durable goods order printing 0.8% growth and unemployment rate falling to its seven year low of 5.3% levels.  The US home sales data has also been beating estimates by sufficient margins, which raises the concerns of asset bubble.

Though, Central Bankers have a habit of backtracking of its own forward guidance (Interesting Read) but they tend to have a strong underlying reason for the same. The US FED Chairperson, Ms. Janet Yellen has acknowledged the economic recovery and prepared the markets regarding a possible interest rate hike later this year. So now the real question is – when should FED hike the rate in 2015? When is right time to apply the brakes; when you are going with the current or against the current? If you can answer this correctly, you would realize that if at all US FED wants to hike interest rate this year than September or October would be an ideal time for raising the interest rates, as US economic growth tends to peak in third quarter.Hence, the economy would be resilient to sustain the interest rate hike without losing much of momentum. Moreover, The US economy growth has shown seasonality trend as it tends struggle in first quarter, which rules out interest rate hike in December 

Source: http://www.federalreserve.gov/, www.BloombergView.com

Chinese Market Crashed – Why you should care!

First Published on 14th July 2015

I’ve never been on Wall Street but I care about Wall Street for one reason and one reason only because what happen on Wall Street matters to Main Street – Ben Bernanke

The Greece crisis has lost its charm to Chinese equity market crash, the financial experts are now more worried about Chinese economic stability than Greece debt crisis. Chinese equity markets just lost nearly 33% in last one month, yet the Shanghai index is up by 23% year till date. So how much does Chinese equity markets lost last month? Any guesses…!! It was just 150% of India’s gross domestic product, yes nearly $3,000 Bn has been evaporated.

The Chinese equity markets started to gain momentum mid of last year with the expectation of monetary easing by the People Bank of China (PBoC). The Chinese economy has been slowing down from last few quarters with PMI numbers remained close of 50, at times below 50, which indicates the contraction in the economic activity. That said, markets seem to neglect what was happening on ground levels and started to gain on expectation of extra-ordinary steps by Government and Central bank to fuel the economy. The Shanghai index rose nearly 150% in just one year period. This astonishing rally came under light of 4 times interest rate cut by PBoC to 4.85% level and increasing participation by the retail investors. The margin trading remained the first choice of the retail investors, who did not think twice to pledge their real estate to invest in equity.

The Chinese equity markets showed the classical quality of bubble, investors keep on buying irrespective of the underlying values of asset. The prices continue to raise despite the significant downward correction in earnings. Apart from announcing market friendly steps government has been involved in cheer leading the stock markets. Hence the government has a major hand in the bubble formation, which is exactly the reason why government has put its weight behind the market. The Chinese government has delayed the IPOs, allow companies to halt trading in their stocks, allowed pension funds to invest in equity markets, the forced brokers on a buying spree, increase the restriction on short-selling.

In these difficult times, everybody wants to ask a very important question. How fire sale in Chinese equity markets will affect the Chinese economy?  To answer the question lets assess the depth of participation of retail investors. Only 7% of the Chinese population is involved in stock market trading, fairly lower than US and Europe. Most of the retail investors have less $15000, exposure to the stock markets. Hence the current level of retail participation should not be a source of worry. The Chinese financial markets are still much closely managed by the government, which gives it enough fire power to stabilize the market in the medium term.

At last, the current situation in China has enough fire-power to push the world economy towards another great depression, but one should not forget how US FED stabilize the markets after the stock market crash in 1987. 

Source : Bloomberg, CNBC

Will Greece Default ?

First Published on 24th June 2015

The China Republic, world’s second largest economy, has been outperformed by Greece, a country on the verge of default. Recent Google search data showed that in the month of June market participants have searched Greece crisis significantly more than a brewing Chinese crisis. The Greece crisis has been at center stage ever since the victory of Alexis Tsipras, who had won the Greek election on the promise of reducing austerity. Mr. Alexis Tsipras believes the EU and IMF must ease the terms of the loan and leave Greece independent when it comes to fiscal policy. On the other hand, the EU and IMF leaders have little faith in the Greece policies and want to implement strict norms to achieve a fiscal surplus.

The Greece has to make a payment of € 1.6 Bn, which it does not has, by Tuesday to IMF to avoid the default. Hence the Greece has continued on its hitherto followed path of negotiating with its lenders to issue a new loan to repay the previous one. First things first- will Greece default this month, or say, this year? From a game theory perspective the answer is ‘A Big No’. From the perspective of Greece, ‘An event of default’ would be a disaster and it would take at-least a decade if not more to regain the confidence of investors. From the perspective of lenders, EU and IMF, ‘An event of default’ might lead to a chain of defaults in Europe, pushing back European economic recovery, which is already breathing on borrowed oxygen. On the other hand, a deal will be a more of a balance sheet transaction than cash Flow. The funds sanctioned by lenders will be used to repay the loan to the same lender. Hence, both the participants have a lot of incentive to avoid default in near term.  

What will happen in the long term? Frankly speaking, Mr. Tsipras has made electoral promises (high pension, high wages and high public spending) which he just can’t not afford. From the political perspective, this case has few things in common with the situation of Aam Aadmi Party in Delhi, where in Mr. Kejariwal had made unrealistic and anti-growth promises just to gain short term popularity. Just like Mr. Arvind Kejariwal has to hike the electricity bills Greece will succumb under EU pressure. Greece political class must understand that it can no longer afford recurring negotiation with lenders and it should start putting growth above the public friendly policies.

For European Union and IMF, it is more of problem of principle than funds as ECB is already printing nearly € 2 bn per day, more than Greece’s current payment. The European Union wants to set an example that an indebted country must practice policies of fiscal discipline, which will result in fiscal surplus. Unlike Greece, other troubled European countries like Spain has running a plunging primary budget deficit, strong growth, rapidly rising productivity, and a burgeoning trade surplus.    

At last, the biggest risk for the financial markets is the reckless behavior of Greece leaders, who believe that EU and IMF just can’t afford a Greece default. A similar state of mind was shared by Dick Fuld, CEO of Lehman Brothers ultimately leading to the demise of the bank.

Source: Google Trend Bloomberg

Whose benefit anyway?

Indian railway budget has been long used for fulfilling political promises, every year government announces new trains and new tracks without considering the financial feasibility. After ages Naredra Modi government announced a railway budget, which actually addresses the operational challenges of railways. The theme of FY 2015-16 budget was centered on improving the operational efficiency, passenger experience and increasing private-public investments.

The government has announced that the passengers can now book tickets 120 days before the date of Journey. The announcement has been a good news for few, who plans their travel in advance and it is irrelevant for someone like me, who plans journey hours before the departure. There is only one clear winner – ‘Indian Railway’. The Advance booking facility has been long used as working capital financing by Airline industry, which is ready to offer hefty discounts for the same. On the other side, the Indian railway does not provide any discounts owing to the fact that it does not have any close competitor.

Indian railway’s top line stood near INR 160,000 Cr for FY 2014-15, the passenger segment contributed just 27% and Goods earnings fetch remaining 73%. Reserved passenger segment fetches nearly INR 12,800 Cr, nearly 8% of the topline. Now to ‘Guesstimate’ advance amount collected by Railway, one needs to estimate the average advance booking. The demand of railway tickets on peak dates can be understood from the fact that confirmed tickets for 29^th August (Rakhi-Celebration) is not available since 10^th May 2015. To understand the advance booking status for a normal day, I have considered journey from Mumbai to Gwalior. In Mangala Lakshadweep Express no confirmed tickets are available for next 80 days (more than two and half month) for 81-120 seats are on an average 50% booked.

If we extrapolate this observation to whole reserved segment even by conservative estimates seats are fully booked for 60 days and for 61-120 day period the seats are on an average 40% booked. As per these estimates railway would have collected nearly advance of INR 2986 Cr (12800*60/120 + 12800*60*0.4/120)/3 Hence at any given day, railway has advance ticket deposit of 2986 Cr. The Railway would have been earning nearly 8% return on this fund, which lead to an earning of nearly INR 66 Lac per day.

Interestingly the Railway would be earning far more than INR 66 Lac per day via advance booking system. As railway issue nearly 30% more ticket than actual capacity under waiting system. Though railway refunds the amount in case of ticket does not get confirmed, but it surely earns interest on the same!

Source: Official Railway Budget  & IRCTC