Decoding the global macro environment

Dear Investors,

This article will focus on answering the below questions around,

• What’s happening to Yields & Currencies globally?
• Why is the $ going up?
• Why is INR performing better than the most?

Lets get started,

(Q1) Where did all of this start? 

(1a) COVID put the breaks on all kind of economic activities, fear of GDP slowing down, Individuals losing jobs, Companies making losses etc.

(1b) To counter, central banks globally unleashed a liquidity package by lowering rates (so that loans become cheap & you buy more stuff) & doing Quantitative Easing (QE) / buying back bonds (Similar to when you buy an FD from a bank, you give bank the money & increase the liquidity with the bank)

(1c) Suddenly everyone had monies or could borrow at almost 0% & all this money started chasing stock markets & commodities (rates were zero so no one wanted to invest in fixed income)

(1d) Yields were going down, Stock Markets went up, commodity prices went up & hence inflation went up (Demand-pull inflation - An inflation that happens because there is demand) 

(1e) Along with liquidity, Russia - Ukraine war & China zero tolerance to COVID & political agendas created supply side problems thereby fueling Inflation even further up (Ex: Supply of Gas become a problem)

(Q2) So what’s the situation now? 

(2a) You have inflation because of both, liquidity led Demand & Russia + China led Supply problems.

(2b) You cant control the supply side problem as a central bank because neither Russia & nor China is in your control & hence the focus is on how to reduce liquidity so that the demand driven inflation can be controlled

(2c) Which ever central bank infused more liquidity has more demand inflationary pressure today (US & UK)

(2d) US & UK have an inflation target of 2% but their inflation is at 9% vs India which infused less liquidity & hence target is 6% & inflation is at 7%

(Q3) What are central banks doing to reduce the demand led inflation?

- Increasing rates & Quantitative Tightening (QT - It’s the opposite of QE)

(3a) By increasing rates, central banks are trying to bring demand down (Mortgage rates in the US have gone up from 2% to 7% in 1 year) 

- US has already increased rates by 3%

- UK has by 2.25%

- India has by 1.4%

(3b) Quantitative Tightening - Central banks have started selling the bonds they purchased during QE. When they sell the bonds, they receive monies from the market & thereby reducing the liquidity with the market

(Q4) How did this affect the markets?

(4a) Equity (Negatively)

- When rates go up, demand goes down as loan becomes expensive

- When rates go up, fixed income starts to look attractive. US 2Y is at above 4% & so money starts flowing there

- Equity valuations start to look expensive with rising rates

And hence, Equity markets have fallen globally

(4b) Yields (Go up)

- When central government stops buying bonds / sell bonds, the demand for bonds fall & hence the price falls. Bond prices & yields are inversely proportional & hence yields go up

- For example, on a 100-rupee bond, if you are getting 6% interest, the yield (return) is 6% but if the price falls to 90 & you are still getting 6% interest, the yield is 6.6% (6/90)

- Yields went up globally

(4c) Currency (Negatively)

- Increase in inflation reduces the purchasing power of the currency. With 100 rupee you may be able to buy a pen today but if inflation goes up, the same pen will be expensive & you will not be able to buy it with the 100 you have. So the value of 100 has fallen.

- The more money you print, there is more supply of your currency & hence the value falls.

- Almost all currencies have devaluated against the $

(4d) Gold (Negatively)

- Gold is bought in $’s globally. So if the $ goes up, price of the gold goes up & hence demand falls & so the price of Gold falls

(Q5) But $ was printed the most & there is inflation in the US then why is $ going up?

(5a) $ is a risk free asset, when ever there is risk off in the market, the monies flow into $

(5b) When you increase rates, it’s a signal that my economy is strong & increase in rates wont derail our growth. Strong economy deserves stronger currency. US has raised the highest rates & hence $ is up

(5c) US does not import oil & is self dependent. Another reason why its trade deficit is better than most & hence a stronger $

(5d) Interest rate differentials vs Europe & Japan is also helping the $ (have written about it earlier also)

(5e) Most importantly, $ is moving higher because the other economies are weak & hence their currencies are weak which is benefiting the $. $ has not really moved higher vs the EM currencies 

(Q6) What did Japan do earlier in the month?

(6a) Japan has not been increasing rates & does not have a very aggressive policy stance & hence yields are still very low & Yen kept falling vs the $

(6b) Japan intervened in the forex market & bought Yen which helped & Yen appreciated 2% vs $

(6c) This is a temporary measure & may not make any material change

(Q7) What did UK do?

UK is confused as hell. Now that you understand, you decided.

-       UK cut taxes where by increased liquidity

-       Did Quantitative Easing by buying bonds

What do you think should happen to GBP & Yields? You should be able to answer.

(Q8) Why is India so resilient on currency, Yields & Stocks?

(8a) RBI has done a brilliant job. We dint infuse a lot of liquidity & that’s the first saving grace

(8b) Our macros are much more stable like Inflation at 7% vs Target of 6%

(8c) We started increasing rates at the right time unlike others who were behind the curve

(8d) Credit off take & Domestic demand is much better

(8e) We are also receiving & expected to receive a larger share of the allocations that no long want to buy China & Russia. 

Closing remarks,

- Yields & $ have to stop rising for Equity markets to stabilise globally

- India cant stay insulated if the world goes south, we can only outperform

Happy Investing!

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Until next time,

Kirtan Shah

Founder & CEO

Credence Wealth Advisors