The extended move on the dollar index over the past six days suggests bad news for equities, particularly emerging markets. The bond market is showing signs of worry due to the US government’s high spending and the potential for a shutdown. Higher bond yields are ultimately negative for equity markets, leading to more money flowing into dollar bonds and pushing up the value of the dollar. This correction is considered healthy, but emerging markets like India may be at a disadvantage due to rising yields.
What is this extended move on the dollar index for the last six days indicating? Traditionally we spell bad news for equities, especially emerging markets?
Yes, true. I would say that these are relatively indirect indicators. The more direct indicators include the entire bond vigilantism market is undergoing. Moody’s said that if this time there is a shutdown, they might again review the ratings. The US government is issuing $10 billion of bonds every day. At some point, this tough conversation about the entitled expenses is needed. It is broadly about 55-60% of what the US government spends. No party is willing to do that. In that scenario, it is unthinkable that the bond market will not get worried. And that is being reflected in the bond yields.
If that happens, it is ultimately bad for equity markets which also means that more money will flow into dollar bonds because they are paying so well and this ultimately pushes the dollar up. I understand that for the emerging market, these are the headwinds. But the US is not too safe either because again, there are questions around earnings.
Rates are going to be higher for a bit longer. The Federal Reserve last week clearly revised the dot plots and this time they are saying there are no cuts at least till the middle of 2024. If we put all this together, the picture is that when the rates are 5.5% with another 25 basis probably coming, can the markets be at 20x multiples? By the way, the entire rally was hinging on just seven stocks. That is also kind of coming back to roost. So that is broadly the global setup and it is okay. It is a healthy correction. I think we do need some bit of that.
What does it really mean for emerging markets like India? Morgan Stanley last evening said that rising yields in the dollar index could be very disadvantageous for emerging markets. Back home in the region, Thailand hiked rates. And now everybody is eyeing the PCE data on Friday. Which way do you think it could tilt?
Yes. People are wishing this time that if the government goes into a shutdown, federalism might not have any data to look at, at least in the November meeting. But that is on the lighter side. But the view has become clear that the market was running ahead with an expectation that the inflation is cooling down and we have kind of achieved that nirvana of soft landing. That was the whole premise. But clearly this time Fed has really shelved all those plans. They have said this is no time to cheer.
I would back that up because look, we have come from zero to 5.5%, and there is only a marginal impact. Core inflation is 4.2-4.3%. It is way too high. More troubling is the wage inflation and the core services which are very sticky within the four handles.
This is going to stay like this for a while, right. We had pandemic excesses, we overspent, there was pull forward of the demand, companies made a lot of profits. We are settling down now. And it is going to bother both the US and emerging markets. Ultimately out here, the market is trying to adjust the likely rise in earnings. They have hovered between 210 to 240 for S&P, we do not know where they land up for 2023.
It is the same with emerging markets. The markets will have to settle down a bit and re-evaluate what is the more normal growth rate both in terms of economy, economic growth and the earnings that is where I stand.
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