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THE WEEK AHEAD

The Economic Data calendar for the week of the 23 of September through the 27th is full of critical releases and events.  Attached below is a snapshot of some (though far from all) of the headline numbers that we will be focused on.

 

THE WEEK AHEAD - week


WILL DR. RAJAN’S POLICY PRESCRIPTION CURE INDIA?

Takeaway: India may finally be starting on the long road to correcting its structural imbalances.

SUMMARY BULLETS:

 

  • Aided by new RBI governor Dr. Raghuram Rajan’s appropriately hawkish monetary policy, we think the Indian economy may finally be starting on the long road to correcting its structural imbalances.
  • That said, however, any meaningful adjustments will require the Indian economy to “take its medicine” by undergoing short-term pain for the sake of long-term gain.
  • Perhaps most importantly, it is still unclear how much of that “prescription” will be tolerated ahead of next year’s parliamentary election.
  • A more-traditional hawkish monetary policy mix should provide some support for the rupee over the intermediate-term TREND, though that same mix should weigh on India’s equity and debt capital markets over a similar time frame.

 

Overnight, new RBI governor Dr. Raghuram Rajan hiked rates. That’s a big deal in India, where, despite the country having a near world-beating inflation problem over that time frame (YoY WPI has averaged +7.1% since 3Q11), the RBI has not hiked either of its benchmark policy rates until now. In fact, those rates have been cut by a cumulative -125bps since peaking in OCT ’11.

 

WILL DR. RAJAN’S POLICY PRESCRIPTION CURE INDIA? - 6

 

Bravo, Dr. Rajan. Bravo.

 

On the move, both the repo and reverse repo rates were increased +25bps to 7.5% and 6.5%, respectively. The cash reserve ratio was held flat at 4%. Inclusive of today’s price action, 1Y OIS are now trading at a 135bps premium to the repo rate; that premium has shrunk -131bps MoM amid pro-EM FX Global Macro beta, but is still up +113bps on a 3M basis.  

 

WILL DR. RAJAN’S POLICY PRESCRIPTION CURE INDIA? - 5

 

Interestingly, despite the INR being down -13.4% vs. the USD over the past 6M, not one of the 36 analysts surveyed by Bloomberg expected Dr. Rajan to hike rates.

 

WILL DR. RAJAN’S POLICY PRESCRIPTION CURE INDIA? - 2

 

Perhaps Bloomberg should’ve surveyed us; it would appear that we were the only firm openly expecting Dr. Rajan to come out of the box in a hawkish manner (refer to our AUG 6 note titled, “WILL THE INDIAN RUPEE MEET ITS [NEW] MAKER?” for more details).

 

Even more interestingly, by cutting the marginal standing facility and bank rates by -75bps each (both are now at 9.5%) and lowering the daily balance requirement for the cash reserve ratio to 95% from 99%,  Dr. Rajan started to unwind former RBI Governor Duvvuri Subbarao’s previous “extraordinary” measures designed to curb volatility in the rupee.

 

It is our view that these incremental measures should be taken as a message to market participants that Dr. Rajan won’t try to be as cute as his predecessor when it comes to defending India’s currency. Thus far, Dr. Rajan has introduced himself to market participants as a monetary traditionalist who favors using blunt policy tools to get the job done.

 

The one caveat being that on SEP 4 Dr. Rajan offered concessional swaps for Indian banks’ FX deposits, with the intent of boosting the country’s FX reserves. That being said, the rupee was still in the process of making all-time lower-lows back then, so we’ll write that off as a one-time deal.

 

Let us refocus our attention back to his current job, which he himself has defined as needing to tackle India’s inflation problem [via promoting currency strength and tightening domestic monetary conditions]. Per this morning’s commentary:

 

  • “We want to fight against inflation and we’ll bring it down. The goal is to slow wholesale price inflation to below 5%.”
  • “Today’s steps start the process of a cautious unwinding of exceptional measures taken since July to reduce exchange rate volatility.”
  • “They also intend to address inflation risks to mitigate pressure on the rupee and create conditions for revitalizing expansion.”

 

Amalgamating all of these signals leads us to conclude what we had already concluded six weeks ago – Dr. Rajan will be more hawkish than his predecessor Duvvuri Subbarao, who was obsessively focused on stimulating economic growth to a fault (something we have written about many times in our bearish work on India over the years).

 

So what does this all mean to India’s GROWTH/INFLATION/POLICY dynamics?

 

It’s safe to conclude that India is likely to finish the year mired in Quad #3 (i.e. Growth Slowing as Inflation Accelerates), as reported inflation plays catch-up to recent currency weakness. Moreover, too much foreign capital has been withdrawn from the Indian economy in recent months (-$1.9B out of India’s equity market and another -$9.1B out of India’s credit market since MAY) for us to expect anything but sequential deterioration in real GDP growth throughout 2H13.

 

WILL DR. RAJAN’S POLICY PRESCRIPTION CURE INDIA? - INDIA

 

WILL DR. RAJAN’S POLICY PRESCRIPTION CURE INDIA? - 8

 

The aforementioned outflows have certainly weighed on India’s local currency fixed income markets (2Y Yields +21bps DoD and +126bps on a 3M basis; 10Y Yields are up +37bps DoD and +118bps on a 3M basis) and we anticipate Dr. Rajan will continue to perpetuate selling pressure via continued hawkishness over the intermediate term.

 

WILL DR. RAJAN’S POLICY PRESCRIPTION CURE INDIA? - 3

 

WILL DR. RAJAN’S POLICY PRESCRIPTION CURE INDIA? - 4

 

India’s equity market is tougher call from here.

 

We could see a scenario whereby the market “pulls and Indonesia” and starts to celebrate rate hikes as a newfound commitment to economic sobriety; recall that India’s twin deficits (current account and fiscal balances) are in the double digits on a combined basis. If India can shore up its current account imbalance by tightening the screws on domestic demand, we would view that as positive for India’s long-term economic outlook.

 

WILL DR. RAJAN’S POLICY PRESCRIPTION CURE INDIA? - 9

 

On the flip side, it’s tough for us to get to a scenario whereby we see commensurate fiscal tightening out of Indian parliament – especially not with a parliamentary election that needs to be called by MAY ’14. If anything, Prime Minster Singh will be under political pressure to continue “buying votes” like he did back in AUG with his food distribution bill, which plans to spend 1.25T INR per annum (equivalent to 7.5% of budgeted expenditures for FY14) on delivering grain to the Indian poor (i.e. two-thirds of the population).

 

Rather than get too cute with making a low-conviction bull call here on Indian equities, we’ll just stick to our process and anticipate continued weakness over the intermediate term (a couple of quarters in Quad #3 tends to be particularly bearish for a country’s equity market). That is in line with the signal the SENSEX Index provided us on today’s rate hike news.

 

WILL DR. RAJAN’S POLICY PRESCRIPTION CURE INDIA? - 1

 

All told, aided by new RBI governor Dr. Raghuram Rajan’s appropriately hawkish monetary policy, we think the Indian economy may finally be starting on the long road to correcting its structural imbalances. That said, however, any meaningful adjustments will require the Indian economy to “take its medicine” by undergoing short-term pain for the sake of long-term gain.

 

Perhaps most importantly, it is still unclear how much of that “prescription” will be tolerated ahead of next year’s parliamentary election.

 

Have a great weekend,

 

Darius Dale

Senior Analyst


Get Out of the Way, Ben

Takeaway: The greatest threat to US growth recovering is the government intervening in the economic cycle.

Editor's note: The brief excerpt below is from Hedgeye CEO Keith McCullough's morning research. For more information about Hedgeye's research products please click here.

 

Famed investor Warren Buffett told students at Georgetown University yesterday that, “The Fed is the greatest hedge fund in history.” He was trumpeting “how much money” the Fed makes. “It’s generating $80 billion or $90 billion a year probably… and that wasn’t the case a few years back.”

 

Isn’t that fantastic?

 

Get Out of the Way, Ben - Bernanke

 

One of the greatest financial minds in US history is marketing a political message that is about as anti-Benjamin Franklin as it gets. Anti-savings that is. Where in God’s good name do you think these “profits” come from?

 

It’s time to get our money out of the Fed’s hands and back into the hands of The People. We know how to generate returns. We’re the ones who are going to be doing the hiring when we make money. All the Fed’s “profits” do at this point is tax the American consumer. It’s called Down Dollar driven inflation. It’s regressive.

 

The greatest threat to US growth recovering is the government intervening in the economic cycle. There has never been a sustained US economic recovery that did not coincide with:

 

1.       Strengthening US Dollar

2.       Rising US Interest Rates

 

Why doesn’t every discussion about the Fed start and end with that?

 

Get Out of the Way, Ben - 888

 

 

 


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PREDICTION: MERKEL WINS

Takeaway: While we believe Merkel will remain Chancellor, it’s unclear who her coalition partners will be.

German Federal elections will be held this Sunday. The race has been a tight one; not only in the last few weeks, but also over the last few months. While we believe that Angela Merkel will remain the Chancellor, with an estimated 30% still undecided, it’s unclear who her coalition partners will be. 

 

PREDICTION: MERKEL WINS - merks

 

In polling week-over-week, Merkel’s CDU/CSU party has held 40% while her current coalition partners, The Free Democrats (FDP), slipped half a point to 5.5%.  The opposition, led by Peer Steinbrueck’s Social Democrats (SPD), gained 1% on the week to 27%, while its potential coalition partners the Greens lost -2% to 9% and the Left gained half a point to 8.5%.  Other Parties, which include the anti-Euro Alternative for Germany (AfD), gained 1 point to 10%.

 

The polls equate to a lead of 1% for Merkel’s party with its current FDP coalition partners over the opposition SPD in coalition with the Greens and the Left.  Note that despite slight shifts in the polls, Merkel’s 1% advantage this week is the same as she had a week ago.   (See charts below)

 

As it relates to Monday’s financial markets, we expect that any coalition government that is formed with Chancellor Merkel’s party will represent a smooth transition to the market. 

 

PREDICTION: MERKEL WINS - hed1

 

PREDICTION: MERKEL WINS - hed2


Heading Into Germany’s Election on Sunday, Merkel Wins, Coalition Still Uncertain

German Federal elections are approaching this Sunday and the race has been a tight one, not only in the last weeks, but also the last months. While we believe that Merkel will remain the Chancellor, with an estimate 30% of pollster still undecided, it’s unclear who her coalition partners will be. 

 

In polling week-over-week, Merkel’s CDU/CSU party has held 40% while her current coalition partners, The Free Democrats (FDP), slipped half a point to 5.5%.  The opposition, led by Peer Steinbrueck’s Social Democrats (SPD), gained 1% on the week to 27%, while its potential coalition partners the Greens lost -2% to 9% and the Left gained half a point to 8.5%.  Other Parties, which include the anti-Euro Alternative for Germany (AfD), gained 1 point to 10%.

 

The polls equate to a lead of 1% for Merkel’s party with its current FDP coalition partners over the opposition SPD in coalition with the Greens and the Left.  Note that despite slight shifts in the polls, Merkel’s 1% advantage this week is the same as she had a week ago.   (See charts below)

 

As it relates to Monday’s markets, we expect that any coalition government that is formed with Chancellor Merkel’s party will represent a smooth transition to the market. As we describe further below, much of this “ease” is built on the fact that the SPD has a very similar outlook on EU and Eurozone policy.

 

Heading Into Germany’s Election on Sunday, Merkel Wins, Coalition Still Uncertain - yy. bar poll

 

Heading Into Germany’s Election on Sunday, Merkel Wins, Coalition Still Uncertain - yy. lt poll

 

 

We Expect Merkel Remains Chancellor, But Her Coalition Partners Are Uncertain

  • A critical lynchpin surrounds how much support the FDP receives. The FDP has been a weak coalition partner for Merkel, at times struggling to retain the mandatory 5% level across state elections.  Currently polling around the 4-6% level, FDP support is absolutely critical for Merkel to win a combined majority with her CDU/CDS party, if she does in fact want to extend her coalition.  It’s uncertain if the anti-euro Alternative for Germany Party (AfD) may sway voters away from voting FDP.
  • CDU/CSU and FDP Coalition Wins (known as the Black/Yellow Coalition or in German, Schwarz-Gelbe Koalition): We assign a continuation of the current coalition as the most likely outcome. Chancellor Merkel has enjoyed the popular support of the people. Despite dissatisfaction in bailing out member states, Germans have broadly applauded the way in which she’s handle the sovereign debt “crisis” and the majority of Germans favor remaining in the Eurozone.
  • CDU/CSU and FDP Coalition Does Not Win:  We expect the formation of a coalition government between Merkel’s CDU/CSU and Steinbrueck’s SPD (also known as the Grand Coalition, or Grosse Koalition), despite statements from Steinbrueck that he would not form a coalition with Merkel. Germany’s last Grand Coalition was in 2004-9.
  • On the anti-euro AfD party and undecided voters: Key considerations to this election are the support that the AfD party may receive (it’s currently around 3%, or below the 5% required to make it in the Bundestag, the lower house of parliament) and the large number of undecided voters, over 30% according to some polls. Commentators suggest that Germans may be embarrassed in polls to admit support for the AfD, and therefore the party will poll higher in the actual vote.  The AfD is a vehicle to express dismay with the Eurozone project and bailouts of member states.  It’s unclear just how much support they might come out with. 


CDU/CSU vs SPD: EU Policy Positions and Market Outlook

  • A key takeaway is that if the current coalition wins or a Grand Coalition with the SPD is formed, both coalitions are orientated in the same way on most EU policies, including:
  • Austerity: both parties favor fiscal consolidation at the state level, especially as a prerequisite for bailout funding,
  • Eurobonds: both parties are against issuing Eurobonds,
  • On the Banking Union: both are in favor of greater separation of ECB monetary policy and its supervisory role over the banks and regulation at the national level; both are opposed to a deposit guarantee fund,
  • On Greece: both parties recognize the likely need for a 3rd bailout; both are delaying any major decisions until after the election,
  • The outcome: Eurozone policy will like be unchanged; an “easy” transition should not disturb the markets.

 

EU/USD Levels (Updated)


Given The Bernanke’s “No Taper” announcement on Wednesday, our quantitative support levels on EUR/USD have moved higher. TRADE support was in the $1.30-31 range prior to the announcement, now it’s at $1.33, and what was intermediate term TREND support at $1.31 is now our long-term TAIL support line.  We expect an easy transition to Merkel’s new government will provide only further support in this cross, aided by a weaker USD on the back of Bernanke’s decision to push out the prospect of tapering its quantitative easing program.

 

Enjoy the weekend!

 

Heading Into Germany’s Election on Sunday, Merkel Wins, Coalition Still Uncertain - yy. eur usd  

 

Matthew Hedrick

Senior Analyst


The Nike & Under Armour Show

Takeaway: From a brand perspective, it’s the Nike and UnderArmour show.

Editor's note: What follows below is a brief complimentary excerpt of a report released earlier this week by Hedgeye Retail Sector Head Brian McGough. For more information on how you can access McGough's highly-regarded research, please click here.

 

The Nike & Under Armour Show - shoe2

 

KEY TAKEAWAY TODAY

Athletic footwear sales continue to teeter on the zero growth mark in the US, though Athletic Apparel once again saves the day with growth in the low double digits. From a brand perspective, it’s the Nike and Under Armour show. The only other brand that’s showing up to play is Skechers.  

 

The Nike & Under Armour Show - bri1

 

The Nike & Under Armour Show - bri2

 

The Nike & Under Armour Show - bri3


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