Inflationary Pressures Drive Cable!

UK’s CPI inflation has been on an uptrend and spiked to 2.9% in August (Y-o-Y). BoE’s MPC committee has acknowledged that UK’s inflation is likely to remain above its target and might spike above 3% in October. Though, Mark Carney has been suggesting that higher yearly inflation is solely because of weaker GBP/USD levels. But there are few signs of inflation pick-up on a month-on-month basis, as discussed earlier







UK’s monthly CPI inflation, which is by nature volatile due to seasonality spiked to 0.58% in August. It is note-worthy that month-on-month inflation does not have the benefit of lower cable, hence can be attributed to changing dynamics in the UK economy. Going forward, it seems BoE has to act sooner than later to manage inflationary pressure in economy. Interestingly, Carney himself has acknowledged that Brexit would be inflationary in nature amid changing labor market dynamics.

GBPUSD Chart:





Technically, GBP/USD pair has given a clear break-out from channel close to 1.3400 levels and also broken previous high of 1.3450-70. The pair can be bought at current levels of 1.3480-1.3490 range with tight stop loss at 1.3435 level. First target would recent high of 1.3610 and next target of 1.3680, last seen in June 2016



Source: Bank of England

Bloomberg

Office of National Statistics

FX Reserve - 400 Bn Mark!

During one of press meets as RBI Governor, Dr. Raghuram Rajan had talked about creating a bullet proof balance-sheet for the country. These comments were made amid the backdrop of falling rupee, FX reserves and weak macro-economic indicators. India’s macro-economic indicators have improved dramatically as crude tumbled to historic low and India became darling of global investors. Rapid decline in import bill (falling oil-Prices) along with sustained foreign flow in domestic market has led to steady appreciation of rupee viz-a-viz to its global peers and healthy growth of FX reserves.

FX Reserve:

India’s forex reserves, which had come under pressure in 2013, are in touching distance of magic figure $ 400 Bn. Consequently, India has nearly 12 months of import covers instead of just 6 months in 2013. This increase is well supported by sharp decline in India’s import bill, which slumped from $490 bn to $ 382 Bn in 2017. It is note-worthy that there has been sharp decline in overall trade, which is dragging the growth lower.

Forex Buying in Forward Markets:

Ever-since demonetization RBI has been battling with excess rupee liquidity, of nearly INR 3 trillion, using various tools at its disposal. This liquidity overhang has retrained RBI’s ability to buy dollars in spot market, as it will lead to increase in INR liquidity. Consequently, RBI has been actively paying in the forward markets, in various maturities, to delay delivery of INR.








Source- RBI Monthly Bulletin

As above chart depicts, RBI has bought nearly 7 Bn in the forward markets, between 30 June 2017 and 31 July 2017, in the bucket of 3 months and up to 1 year. Though, it is slightly far-fetched, but it seems that RBI believes downside risk of excessive rupee appreciation is more critical than paying forward premium. Going forward, It seems RBI might remain active in forex active to stem excessive appreciaton.

INR 200 Note

Reserve Bank of India had spent nearly INR 80 bn on printing new notes, special thanks to demonetization. Nevertheless, over the years, RBI has been spending close to INR 30 bn to replace soil notes and increase the supply in the system. Recently launched INR 200 note is expected to reduce this cost as it will reduce the numbers of notes required for day to day transaction

Above figure depicts, minimum number of notes required to complete the transaction, with or without INR 200 note.

Above figure depicts, change in physical note requirement for various amount transactions using the integer function.

Above chart depicts, RBI will achieve nearly 12% efficiency by introducing INR 200 note. It can reduce regular note printing cost (INR 30 Bn FY16) by INR 3.6 Bn.

Inflation from Parallel World Contd.

To substantiate the idea, “As GST implementation would force the informal sector to start routing its business through proper channel, traders will start paying taxes and there could be a significant jump in CPI inflation”, discussed in previous blog, one needs to analyze India’s CPI basket.

We have divided India’s CPI basket in two categories. GST Immune sectors, where GST tax rates are equal or lower than previous regime and have relatively less exposure to informal sector. This list includes food (excluding prepared Meals), health, education and housing. GST vulnerable Sectors, where informal sector is largely at play and GST rates are higher than previous regime. This list includes clothing, footwear, household goods, prepared meals, transportation, amusement, personal care and tobacco products.

GST Immune Sectors: Though, majority of CPI basket will have little impact of GST implementation, but it faces an unfavorable base effect along with supply side risk.

 GST immune sectors, which had actually deflated on month on month basis last year, have spiked by 2.21% in July. It is also note-worthy that food inflation is highly volatile and majorly depends upon the supply side risk, including monsoon. 

Above chart depicts, there is little certainty that food inflation will repeat its stellar performance of last year again. Interestingly, food inflation has been on a flip-flop trend on yearly basis as it fell in year 2014 then rebounded in 2015 and fell again in 2016. Food inflation in July 2017 has spiked by 2.81%. GST vulnerable Sectors: GST vulnerable sectors, which constitutes a major part of core inflation, have remained sticky above 3.70%. We expect GST vulnerable sectors to observe a significant spike in inflation in the near term due to higher taxes and higher compliance by the informal sector. But it is difficult to fore-cast extent of inflation.

Source: CPI Data 

Inflation from Parallel World

Globally, GST implementation had led to higher inflation and weaker growth in short term. Against this backdrop, GST council has either reduced or kept unchanged effective tax on list of goods and services, which directly impacts retail inflation. Arvind Subramanian, Chief Economic Advisor, has argued time and again that lower taxes will lead to lower inflation and possibly increase the demand in volume terms. Theoretically, there is little flaw in the argument. In an organized and competitive setup the reduced taxes will let companies to reduce prices and attract higher sales.

Unfortunately, a significant part of Indian economy is contributed by informal sector, which has been evading taxes for ages. Though, this informal sector has little contribution to tax collection but it is highly competitive i.e. traders have to pass on the gain of tax evasion to remain competitive. Hence, theoretically, tax evasion is acting like tax credit by government, which was fuelling the economy. It is note-worthy that first Demonetization and now GST has forced a lot of traders to start routing their business through proper channel. Once, these traders, who works at paper thin margins, start paying taxes, there would be a significant jump in prices. Formal sector is also likely to witness in increase in semi-furnished raw material. It remains to be seen how much its cost would be passed on to end consumer.

Retail Inflation:The latest RBI monetary policy categorically mentions that retail inflation is expected to pick up on account of unfavorable base effect. CPI inflation in month of June has fell to its life time low levels of 1.54% y-o-y basis, interestingly month-o-month inflation rose sharply by 0.53% (6.5% on annualized basis). It is also note-worthy that retail inflation has been on upswing after demonetization as it rose from -0.6% in December to 0.53% in June.

Though, it remains to be seen how inflation in informal sector will push overall retail inflation higher, but there is little hope that month-on-month inflation will ease in current environment. Hence, it is safer to presume that we will see more hawkish tone from RBI in next few months.

How to Trade this hypothesis?

India’s 10 year bond is trading at nearly 40 bps tenor and credit premium from repo rate. We can buy yield at current levels, 6.44% with stop loss below 6.34%, previous low on June 2016, with a target of 6.65%.

Reference: Reuters

GST impact – Arvind Subramanian

CPI Data

First Published on 7th Aug 2017

Inflation Expectation: Buy BoE’s MPC Sell Carney

Ever-since global financial crisis, major central bankers have been pursuing ultra-eased monetary policy to stimulate their economies and inflation. Almost all of them maintained that their prime target is to fuel inflation, while increasing global market share and currency depreciation are an unintended but favorable outcome. Interestingly, Bank of England nearly sidelined inflation targeting in favor of growth. “Attempting to offset fully the effect of weaker sterling on inflation would be achievable only at the cost of higher unemployment and, in all likelihood, even weaker income growth. For this reason, the MPC’s remit specifies that, in such exceptional circumstances, the Committee must balance any trade-off between the speed at which it intends to return inflation sustainably to the target and the support that monetary policy provides to jobs and activity.”*

*- Bank of England Policy Statement

UK’s headline inflation has been overshooting MPC’s target for a while as it spiked to 2.9% in May(Y-o-Y). Most market participants have attributed this is weaker cable, which is trading more 10% lower on Y-o-Y basis, leading to supply side inflation in economy. Though, year-on-year on inflation has definitely affected by weaker cable, but month-on-month inflation should have relatively low impact cable movement. UK’s m-o-m inflation has remained sticky at 0.40% in last three months. (Even a 0.2% m-o-m inflation is equivalent of 2.43%, well above inflation target).

One counter-argument is recent inflation has failed to fuel wage growth in economy. Wage growth remained broadly unchanged at 2.4% against above 3% reading of pre-crisis level.

Month-on-Month Inflation

Jun	Jul	Aug	Sep	Oct	Nov	Dec	Jan	Feb	Mar	Apr	May
0.20%	0.00%	0.30%	0.20%	0.10%	0.20%	0.49%	-0.49%	0.69%	0.39%	0.39%	0.39%

Year-on-Year Inflation

Jun	Jul	Aug	Sep	Oct	Nov	Dec	Jan	Feb	Mar	Apr	May
0.40%	0.60%	0.60%	0.90%	0.90%	1.10%	1.60%	1.91%	2.30%	2.30%	2.69%	2.89%

Cable Movement

The GBP/USD pair, which had spiked to 1.28 handle on account of MPC vote count, has tumbled nearly 200 pips. Mark Carney has punctured rate hike expectation with fairly dovish comments. The pair has near term supports at 1.2580, previous break-out levels and 1.2550, 200 day moving average. GBPUSD pair can be bought at current levels, 1.2600 with stop loss below 1.2550 levels and target 1.2850.

First Published On 26th June 2017

Will US Fed lend oxygen to Dollar Bulls?

Let us state the obvious, US Dollar bulls have been suffocating over last few weeks. The recent correction in US dollar index, which fell nearly 4% in last four weeks, is due to political drama across the ocean. Cable surged nearly 4 big figures as May announced mid-term election in UK. Market seems to believe that upcoming election will provide stronger mandate to May, which might lead to better Brexit bargain for UK. On other hand, EUR/USD pair surged above 1.09 handle as Macron won the first round election in France and likely to win second round against Le Pen.

Weak Data Points

US dollar has found little support from recent US economic numbers. US GDP grew by just 0.7% in Q1 owing weak consumer spending and seasonal headwinds. Other key indicators retail sales – declined by 0.2% m-on-m, CPI inflation eased to 2.4% y-o-y, consumer confidence slipped to 120.3, remained under pressure.

Key Trigger: Balance Sheet Reduction

Most of FED members had started toying with idea of reducing US FED balance sheet, which is currently nearly 4.84 trillion USD. Interestingly, US FED member Neel Kashkari had argued to normalize FED balance sheet rather than adjusting FED fund rate as tool for monetary policy adjustment.

It is note-worthy that much of FED’s hawkish inflation expectation are/were due to Trump’s tax reforms talks. With US tax reforms still in dark and softness of recent economic numbers, there is further room for FED to remain accommodating. Hence, for US Dollar bulls – any clarity over reduction of FED balance sheet might be only hope!


First Published on 3rd May 2017.
Source- Bloomberg , Trading View

US Dollar - The Trump Effect

Global financial markets have been all over place, when it comes to pricing ‘Trump Effect’, majorly because of the very nature of US president. US equity markets, which were trading with weakening bias ahead of US election results, have rallied more than 10% after Trump’s victory. Financial markets started to price in higher fiscal push and improved inflation in US markets, leading to rally in US dollar and bond yields. The US dollar index had rallied to 103.50 levels, last seen in 2003, amid expectation of higher inflation and sharper tightening of US FED monetary policy. Though, US dollar has corrected a bit after President has raised his concern over stronger dollar, it seems that more uncertainty in US trade and government policies is likely to provide support to US dollar.

Trade Balance Impact: US has been running huge trade deficits for decades now. But it has little impact on the value of US dollar. For instance, since July 2014 US dollar index has rallied more than 25% despite trade deficits of more than $500 bn per year. Chart below indicates the Balance of payment position of US for period Jan-Nov’16 US has a net balance of payment deficit of $ 677.09 Bn, which is majorly contributed by China, Mexico and European Union. A stressed trade relationship will have comparably less impact on US dollar than its counter-parts.

Monetary Policy: Most of US dollar rally, in last two and half year, can be attributed to diverging monetary policy between US FED and the rest of the central banks. ECB and Bank of Japan have been printing loads of money to fuel domestic growth & inflation. Though, inflation has just shown delayed signs of improvement, sharp decline in currencies has rendered support for retaining wallet share in world trade. In case of declining world trade, ECB & Bank of Japan can act more swiftly to adjust their monetary to secure their wallet share. The ECB and Bank of Japan would be better placed to depreciate their currencies, of-course unintendedly than US FED. As US FED is less likely to take a U-Turn, reduce interest rates or start next round quantitative easing. On the other hand, in the event of substantial fiscal push US Fed would be forced to continue its path of interest rate tightening.

Historically, Global uncertainty and financial distress have proved to be a boon for US dollar. US dollar did not lose much of its value even in the 2008 financial crisis, which had its origin in US soil. Global investors have tendency to rush for US treasury and US assets in event of financial distress and global uncertainty, which looks given under Trump administration.

Though, the US dollar index can correct upto 96.50-97.00 levels, which will mark complete unwinding of initial trump trade. The US dollar still remains a buy on dips candidate, consolidating its gains against major currencies.

First Published : 31 Jan 2017.

 Source: Bloomberg
Dollar Trap