Divestment plan brings goods news, may soften yields

Another great run for global equities in the week that went by and the euphoria and awe that overwhelms caution is reminiscent of 1987. That year, on October 19, popularly known as Black Monday, the US stock market crashed 22.6%, and remains one of the largest single-day percentage crash. And coincidentally, the S&P started with a 4% rise in the first few weeks of that year and tax cuts were the driver for the 1987 boom. That is for the history.

The perspective for the moment is that global equities reached record levels at midweek amid continued evidence of synchronised global growth and solid corporate earnings. Yields on US 10-year Treasury notes rose to their highest level since March of 2017, trading at 2.66 by weekend.

Crude oil was little changed, with West Texas Intermediate crude consolidating recent gains around $63.50 a barrel. Volatility, as measured by the CBOE’s VIX jumped to 12.25 from 10 late last week. India’s bellwether Sensex and Nifty indices registered their life-time highs amid cries for caution.

The US indices index tested lows last seen in December 2001 as a US government shutdown loomed. The US government’s funding authority failed to clinch a widely expected stopgap funding deal to continue operations. A short-term shutdown is seen as being minimally disruptive to markets, but a long-term one could prove more unsettling. History shows almost 18 previous episodes of funding crisis have been managed with a one to three week delays. So this event could well fade into those chronicled events. Currency markets sold dollar for a major part of the week and a correction at the least is due, rather overdue.

With Nafta negotiations coming up where the focus is on China’s trade practices, markets are wary that escalating trade tension could weigh on investor confidence. Bank of Canada upped its short-term rates for the third time since June 2017, citing reasons that suggested the central bank was taking cognisance of strong economic data. In an interesting piece of data, US jobless weekly data suggested that its jobless claims fell to a 45-year low. It’s a mega heads-up for Federal Open Market Committee's rate decisions this year. ECB meeting this Thursday will be key to the currency markets. Any move to tweak its forward guidance on the future path of monetary policy may well wait until the meeting in March.

Data from the RBI showed that forex reserves rose by $2.7 billion to register a new lifetime high of USD 413.85 billion. Contrarily, the rupee weakened past 64.10 last week as bunched up demand soured sentiments. With US yields moving past 2.65% and emerging market stock indices at historic highs, risk favors a strong correction in local currencies.

Bond market continues to remain fragile on sentiment as diminishing appetite for bonds and risk of unwinding of the easy-interest regime (not necessarily a hike), keep buyers at bay. In a meeting of fixed income and money market dealers, the RBI deputy governor underlined the importance of having hedging mechanisms and policies to insulate from interest rate risks. This was largely perceived as preparatory for potential tightening and spooked bond yields. The reprieve came from a rather unexpected quarter when the government announced the possibility of reduced borrowing and a potential tone down from the earlier announced incremental borrowing risk

Yields gyrated between extremes and the sentiment is weak. The economically minded will still wonder if the fair value of a 10-year security should be close to 7% as the funding rate is still 6% and inflation, albeit temporary, overshoot in food prices, should remain contained around the target range.

Weekly special auction saw partial acceptance at the long end of the curve and is clearly a message. A weekend news on disinvestment spells good prospects on fiscal gaps and markets should react positively in the weeks ahead. The 10-year benchmark should test the lower bounds of 7.20%.

WHAT'S IN STORE?

On October 19, 1987, popularly known as Black Monday, the US stock market crashed 22.6%, and remains one of the largest single-day percentage crash
Coincidentally, the S&P started with a 4% rise in the first few weeks of that year and tax cuts were the driver for the 1987 boom

The writer is a market expert