Conclusion: Inflation continues to percolate within these economies and we expect further monetary policy tightening in each country over various durations, with China being the most imminent. Furthermore, we expect inflation to continue to remain a headwind for many countries globally and that will eventually lead to slowing economic growth (via policy tightening) which is negative for equities.
Position: Bearish on Indian equities.
Chairman Bernanke’s experiment with Quantitative Guessing continues to have unintended consequences, due to the impact of the equation highlighted below:
QG = inflation [globally] = monetary policy tightening [globally] = slower growth [globally]
A brief review of global economic data points highlights the three very key countries’ struggles with inflation (China, India and Brazil). While divergence between each country’s response reminds us that both inflation and monetary policy are local, analyzing them collectively allows us to derive the equation laid out above.
Let us briefly visit each country’s headlines and data points from today’s global macro run for a quick update on the global inflation front:
Country: China; Policy Stance: Proactive
On a relative basis, China has been particularly proactive in their fight with inflation of late, raising bank’s reserve requirements twice this month, hiking interest rates in October, and announcing potential price controls and supply rationing in its food market. In line with our forecast(s), recent data points support our view that additional tightening may be on the way:
- China’s largest banks are being rumored to have hit their government-set caps on lending this year and regulators are monitoring the banks’ loan balances daily to ensure the full-year 7.5 trillion yuan new lending quota isn’t breached. Concurrently, Industrial & Commercial Bank of China Ltd. and Agricultural Bank of China Ltd. are reported to be only extending new loans as existing loans get repaid. Overnight, People’s Bank of China Deputy Governor Hu Xiaolian said China will face challenges meeting its full-year lending target and that China will control the pace of lending for the rest of the year.
- The premium investors demand to hold ten-year Chinese corporate bonds vs. similar maturity Chinese sovereign debt rose 16bps yesterday – the most since Lehman Bros. filed for bankruptcy – on speculation that bank lending curbs will create illiquidity in that market.
- China’s Banking Regulatory Commission has threatened (via its website) to crack down on the use of loan funds for speculation and hoarding.
- China’s benchmark money-market rate rose to a seven-week high of 2.22%. Yesterday’s one-year bill auction saw the lowest amount of yuan sold since July 2008 due to declining demand for the securities, which have yielded 2.3437% for the second straight week. Translation – the Chinese bond market sees additional rate hike(s) in the near future.
For more color on China’s inflation issues, please reference the following reports (email us if you need a copy):
10/19: China Raises Rates… Setting Off a Chain Reaction That’s Bad for Reflation
10/21: China Sets the World Up for a Crash
11/11: Chinese Inflation Data Confirms What We Should Already Know: QE2 Will Slow Global Growth
From a quantitative perspective, China's Shanghai Composite Index is bearish TRADE and bullish TREND:
Country: Brazil; Policy Stance: Reactive, Hopeful
The latest developments out of Brazil are supportive of our views that Brazil will be late off the snap when it comes to fighting inflation. While the latest inflation readings remain comfortably within the central bank’s target of 4.5% (+/- 2%), the recent acceleration in price growth, appointment decisions and hopeful rhetoric from Brazilian officials have the Brazilian bond market as concerned as we have been for the past couple of months:
- The bond market’s expectations for annual inflation over the next two years hit a two year high of 6.68% yesterday, as measured by the breakeven rate between the government’s fixed and inflation-linked debt. The current expectation of 6.68% puts two-year inflation expectations 18bps above the upper band of the central bank’s target.
- Yields on Brazil’s interest rate futures due in January 2012 have jumped 49bps since the start of this month to 11.83%, implying the bond market expects the central bank to raise the benchmark Selic rate to ~13% by the end of next year from the current 10.75%. This latest up-move coincides with fiscally loose rhetoric from President-elect Dilma Rousseff, who herself is a big proponent of spending on social programs.
- It is being reported that President-elect Dilma Rousseff will not ask the hawkish Henrique Meirelles to stay on board as her central bank chairman, leading to speculation that his replacement may not be as vigilant in combating inflation. Today, it is rumored that Rousseff will appoint the 46 year-old Alexandre Tombini a the new central bank chief. This appointment is noteworthy and positive on the margin because it signals to the market some degree of continuity in monetary policy, as Tombini has served as a board member in the central bank since 2005. Further, former Brazilian president Henrique Cardoso has previously flagged Tombini as an instrumental figure in helping design the 1999 inflation targeting plan.
- Treasury Secretary Arno Augustin said yesterday, “There is no reason to expect faster inflation and higher interest rates in Brazil.” Reminds me of another Treasury Secretary whom we’re all familiar with that simply doesn’t get it…
- Shortly after Arno’s commentary, Brazilian inflation, as measured by the IPCA-15 Index, was reported to have accelerated to a 20-month high of +5.47% YoY in the latest reading (mid-November).
- On top of market inflation expectations getting away from Brazilian officials, yesterday’s economic data show that Brazil’s formal employment sector added +204.8k new jobs in October. While down from September’s +246.9k rate, the January-October total of +2.4 million new jobs created is the highest rate EVER for a ten-month period. In addition to the employment tailwinds, Brazilian consumer confidence, as measured by the FGV Consumer Confidence Index, hit a record high in November. The 125.4 reading advanced +2.7% MoM. We have been in print for much of 2H10 documenting the tailwinds of the Brazilian consumer and how robust internal demand will continue to keep upward pressure on inflation readings going forward.
For more color on Brazil’s inflation issues, please reference the following reports (email us if you need a copy):
10/22: Real Commotion in Brazil
11/9: Outlook for Brazilian Interest Rates: Read the Fine Print
From a quantitative perspective, Brazil's Bovespa is bearish TRADE and bullish TREND - for now. Last night it tested a TREND line breakdown, closing below its TREND line of 68,826. It is trading slightly above that intraday, but we'll need to see it close above the TREND line for bullish confirmation:
Country: India; Policy Stance: Inactive, Hurtful
It would be an understatement to suggest India is losing this three-horse monetary policy race. Having shifted from his hawkish stance (six rate hikes YTD) to a more relaxed position, Reserve Bank of India Governor Duvvuri Subarrao has recently signaled to the market that additional rate hikes are not in India’s near future. That would be fine if India had inflation under control; unfortunately, the latest WPI reading of +8.58% YoY suggests India is far from achieving its target of +4-4.5% YoY inflation.
Compounding this blatant lack of vigilance is the RBI’s decision to add fuel to the fire by buying back government bonds from Indian lenders with the intention of increasing liquidity in a cash-strapped banking system that has been struggling to meet demand for loans. Fueling speculation when inflation is running at twice the target rate is not our idea of risk management. We expect further tightening ahead, but only after inflation becomes the problem it was in 1H10, which suggests the RBI will be slow to react to this burgeoning issue. For now, the Indian currency market is taking the other side of the trade:
- The premium investors pay to exchange the rupee for dollars in 12-month forward contracts vs. the spot rate has dropped -84bps since the end of last month and is down -1.36% from its nine-year high of 6.08% on October 27th. The drop signals that investors are anticipating smaller increases in Indian interest rates over the duration of the contract.
- The muted outlook for interest rate hikes over the near term has many investors less optimistic on the rupee, as the premium paid for options offering protection against declines in the rupee have grown +229bps to 260bps from a 16-month low of 31bps on September 20th.
For more color on India’s inflation issues, please reference the following reports (email us if you need a copy):
11/2: Eye On Asia: Things Are Getting Ugly
11/9: India’s Two Big Problems
Indian equities got tagged again overnight (down -1.2%), which caused the SENSEX to close below its TREND line. This is new and further confirmation of this price action will lend additional support for our bearish stance on Indian equities:
All told, we remain bearish on equities as an asset class globally because of the spectre of further tightening in these three economies, as well as incremental tightening in other countries. The CRB Index may have backed off its YTD highs recently, but commodity prices remain elevated enough (up +8.3% YoY) to continue to fuel inflation globally and inflation will eventually lead to slowing economic growth (via policy tightening) which is negative for equities.