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Weekly Economic Review - UAE, India, Global Macro

|Includes:Market Vectors Indian Rupee/USD ETN (INR)

Week ending August 2, 2014


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Equity markets in UAE had only 2 trading days this week on Sunday & Thursday due to Eid Holidays, but the market did manage to post some large gains. Banking stocks provided the momentum after posting strong results in the previous week. Arabtec the highly volatile stock was up about 6% in these two trading days recouping some of 19% loss of the earlier week. The largest private sector real-estate company Damac which had listed its stock in London last year, issued a statement in London stating its intention to list its shares on the Dubai Financial Market(DFM). Investors can now convert Global Depository Receipts (GDRs) of Damac Real Estate Development Limited for shares that will tradable on the DFM. Investor have an option of continuing to hold on to the GDRs or converting into equity shares that can be traded in the DFM. This company has a market cap of about $3.5 billion and the promoter will continue to own about 85% of the equity. The GDRs were issued last year at $12.25 and are trading around $16 currently.

Global risk aversion hit Indian markets hard on the last trading day of the week on Friday as both the Indian Rupee & Stock markets went into a tailspin. The Indian Rupee broke out of its trading range of 59.50-60.50 on the upside and traded a low of 61.19 and closed around its low. The fall of 1.8% which was over one rupee during the week was the largest weekly fall since last August when we witnessed such steep falls for several consecutive weeks. The RBI may not be keen to arrest the fall in the Indian Rupee as this move is not really India specific and all emerging market currencies have fallen in sync on Friday. The fall in the Indian Rupee will hold at a level that the RBI finds too low for its comfort and we may not see that till the Rupee hits levels around 63.00 to 64.00. With FX reserves hitting levels close to the all time high at $320.56 the RBI is certainly in a comfortable position to arrest this fall at a level that it thinks is appropriate given the global scenario.

Indian equities which have been trading in stratosphere since the formation of the NDA government two months shed some of the gains in the wake of global risk aversion. As mentioned in our earlier reports currently there is quite a bit of good news priced in and there was a risk of the bull market tapering out in Indian equities. Over the last two years corporate balance sheets have strengthened due to paring down of debt and cost cutting measures in the wake of the slowdown in the economy. Macro fundamentals in India are improving with the investment cycle kicking off with a rebound in the capital goods sector, fears of further interest rate hikes by RBI has receded, the risks of a cut in India's rating is out of the window now. Inflation numbers have come down significantly both at the wholesale & consumer level. Overall this down move in both the Indian Rupee & equities could be used as a good starting point for accumulating long positions for medium to long term investors over the next few weeks.

Global markets were hit hard on Thursday due to four factors. Firstly, escalation tensions in Ukraine as European Union agreed on further sanctions on Russia. Retaliation by Russia could starve Europe of energy resources as Russia supplies from 10-90% of all gas and oil to some of the European countries. This confrontation which is taking the world back to the cold war era is now entering unchartered territories as Russia is moving vast amounts of funds out of Europe into HongKong and other markets.

Second reason which is also related to the first and will have wider implications for large European companies. Adidas the German Sports goods giant lowered full year forecasts on account of increasing risks related to its business in and with Russia and also due to poor retail sentiment. As the situation in Ukraine lingers European companies will face the brunt of this as Russia is a big supplier of raw materials and also a big market for its products.

Thirdly, Portugal's largest bank Banco Espirito Santo posted the largest ever loss of $4.8 billion for a Portuguese bank raising concerns of similar hidden issues in the banking system in Europe. The stock price has slipped from Euro 1.22 in early May to Euro 0.12, a slump of 90% as the entire equity of the bank has been wiped out and it would require a bail out from the Portuguese government to survive or require fresh investors to come in which could wipe out existing shareholders and also bail-in some bond holders. The cause of this loss is even more concerning as this loss was on account of credit exposures without proper approvals & loans and credit lines to family companies just before filing for bankruptcy.

Last but not certainly least is the second default by Argentina since 2001 and the eight time since they issued their first issued bonds in 1824. This time around it is more technical as Argentina has already transferred the required payment to bond holders who agreed to the hair cut in 2001. The problem is with the others who did not agree to the 65% hair cut amounting to only 7% of the bonds holders by value. These "hold-out" investors want to be paid out in full and managed to get a court order to stop payment to the bond holders who have agreed to the restructure. The problem that Argentina faces is that it cannot negotiate a separate arrangement with these 7% of bond holders because the original restructuring with the other 93% prohibit such differential settlements.

Well Thursday produced one of the biggest sell-offs of 2014, in US equity markets with the Dow Jones ending lower by 317 point (1.9%). The market's fear gauge, the VIX Index jumped 28% to 17.9, the VIX had traded an all time low of 10.28 on July 3 and it has a long term average around 20.

The bond markets had a wild ride this week with a sharp spike in yields on Wednesday as Q2 GDP data at 4% (boosted by higher inventories which contributed 1.66%) sent the 10 year yield soaring higher by 10 bps hitting levels close to 2.60%. The mildly dovish FOMC statement with the words "considerable time for low interest rates to continue" sent yields lower and the markets "risk aversion" mode on Thursday & Friday sent yields below 2.50%. Fed Futures are currently fully pricing in a probability of a rate hike by June next year.

At the FOMC meeting another $10 billion of QE was cut bringing it down to $25 billion. The labor market outlook was slightly changed to reflect improvement in unemployment but cautioned that "there remains significant underutilization of labor resources." The comment on inflation was significantly upgraded to "inflation has moved somewhat closer to the committee's longer-run objective." The wordings relating to maintaining the current rate of fed funds rate for a "considerable time" after the QE program ends were retained and Charles I. Plosser dissented as he did not support this language.

In US economic data was mixed with Non-Farm Payroll for July coming slightly below expectations at 209k jobs added, but the numbers for May & June was revised higher by 15k. This is the sixth consecutive months that jobs additions have exceeded 200k which is a strong trend and the average job additions for 2014 is 211k jobs. The very important wage inflation gauge was flat indicating no inflationary pressure from higher wages. This number was especially important after another inflation gauge "Employment Cost Index" the broadest measure of employment cost showed a 0.7% jump q-on-q which had spooked the bond markets. The key to the timing of the rate hike by Fed would be wage inflation as the Fed would not raise rates unless slack in the labor market is absorbed.

ECB fight to keep deflation away seems to be flattering inspite of the liquidity measures as CPI in Europe fell further lower in July to 0.4% and the target of 2% seems to be distant in the rearview with no possible sighting in the near future. The fear with deflation is that as prices keep going lower consumers will postpone spending in anticipation of even lower prices sending it further into a downward spiral. The flood of liquidity that has been unleashed by the ECB to spur inflation and boost liquidity into the economy has resulted in record low yields for European debt where most of these funds have flowed. As per ECB data bank lending to households and non-financial corporation's has fallen each and every month this year. An analysis of the yield of Spanish government bonds gives us an idea to the extent to which money is pouring into European Government Bonds in this low rate environment. Just about 2 years back at the peak of the of debt crisis in Europe 10 year Spanish government bonds traded a high of 7.63 and this has now fallen to 2.56% which is lower than what 10 year US Treasuries are trading at!!

Compiled & Researched by: Shailesh N. Mulki

Disclaimer: This is not a research report as the views and information contained herein are the personal views of the author. These should not be taken to constitute advice or recommendation.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Stocks: INR