Of Secular Stagnation and Other Worries

We have seen quite a bull run in the bonds market since the start of the year. Which has caught many people off the guard. The usual suspects are flow chasing yields after equity peaking off the tops, and risk off from Ukraine crisis. But perhaps something more at play here, and we take a look about the secular stagnation and a global japanification that is priced in the rates markets now. After the good rally this week

The peak nominal equilibrium rate priced in is maximum for USD. This is in spite of the recent difference between GBP and USD. This prices in a convergence of UK and US inflation and a higher long term real GDP for US. The recent bullish phase has been less about re-pricing the pace of rate hikes, and more about the terminal rate, i.e. estimate of natural rate of interest. Except in GBP where there is a large re-price of peak rate time (by 3 years!)

This, in my opinion, reflect a much less optimistic re-assessment compared to last year. The terminal rates should be determined by the potential output of the economy, and the pace of hike is an estimate of central bank’s degree of dovishness. This re-pricing of terminal  rate shows a possible shift downward of potential output itself

This brings us back to the pricing of a possible secular stagnation and Japanification. We run a simulation assuming 1) a further 50bps reduction in the maximum future rates (secular stagnation) and 2) as mentioned under 1, but also the maximum rate is attained 8 quarters from the current priced-in pace of hikes. The effect of these on long end rates are obvious, both depress the long end further, and 2) is more severe than 1). 

However, the interesting point to note is how the curve slopes get re-priced. From current level, scenario 1) shows a flattening, while scenario 2) shows a steepening. Indeed the curve slopes in JPY are in general steeper than G3. I think any re-pricing of pace of hike is less likely, especially if inflation has indeed bottomed out (for USD and GBP). We still have a chance for re-pricing of pace of hike for EUR. So as I see it, flattening to continue in USD and GBP, and expect further steepening in EUR.

Oh, and there is this interesting piece from FT Alphaville. Do check the link. 

NIFTY: Are FIIs Really Overweight India?

I have my doubts

Here is an interesting article from the good folks from FTAlphaville

What is striking is that although the general feeling is that the FIIs have been "euphoric" about India and its' resurgence under Mr Modi as the PM, as I see, the data fails to show the same. Here are couple of charts to drive home the point.

So irrespective of what analysts at foreign banks says, I think a large part of the rally in the Indian equity markets so far this year has been driven by domestic buyers or may be even retail money. And a lots of potential FIIs flows sitting on the sidelines. Through the last phase of the election campaigns and actual elections, my perception is that FIIs have been cautious and decided to follow a wait and watch policy. And it would not take a dramatic positive results for NDA to kick start the next leg of the bull run. A simple confirmation of average exit polls prediction will do.

What Happened in Rates Today!

The euro swaps saw an almost parallel rally, continuing yesterday's move. The dollar swaps rallied with a slight flattening. And the awesomest moves were in sterling swaps, with a sharp rally and an equally sharp steepening across the curve, following BoE's report on inflation. Is it overdone? More likely than not. But fading still looks on the riskier side. Best to book profits on long steepeners and short payers. The next expected big move is not before June ECB.  But honestly I have no idea what is behind the  big sterling moves today. The report dashed the hope of imminent hike in bank rate, but was nowhere beyond expectation. And given recent moves and positioning to best of my knowledge, don't see any strong technical reasons either. Need to dig deeper. Something here is not consistent.

Yet Another India Vs China Story

A very interesting piece from IMF Direct blog!

It captures how the trade integration within Asia has phenomenal compared to other regions globally for last two decades, centered on the China growth story. And it also highlights how this has resulted in increased synchronization, and increased propagation of growth shocks between regional partners. This, is claimed, has given rise to a high correlation among Asian economies, as they provide this chart for quick evidence

And when I look at this chart, I find India has a pretty interesting position. In fact some might argue, based on this chart, that betting on a Chinese shocks can be structured through short Australia and Korea and long India and Philippines, adding statistical leverage.

Although I am doubtful this negative correlation in economies will translate to the correlations in markets in the event of a severe chines slowdown. Irrespective of how good or bad the economic story is, India will face consequences on international financial flows if we see a real serious slow down in China. The question is what happens when the dust settles down. India is a net importer from China, with some overlaps of export to other developed countries. So certainly will suffer much less directly through a slowdown in China. In fact can even benefit from reduced competition in global markets. But by any means economic downturn of the second largest trading partner is no good news, even if it runs a net trade deficit.

But if the slowdown in contained, I think there will be some focus on this issue and India will see some part of the flows from the Asia focused funds, trying to limit Chinese exposure

In fact, long-term market correlation supports this. NIFTY has been much more correlated to S&P 500 ...

... than Shanghai Composite