Saturday, August 17, 2013

Real Game Changer For Global Markets - Germany not US

A very horrible session for Indian bourses on 16th August '13 with almost 6% shaved off BankNifty, almost 800 points off Sensex and 200 points off Nifty. A couple of months ago, I had mentioned that Indian bonds were rallying with a significant reduction of 1% on the coupon rate of 10 Year RBI treasuries. It was a huge positive. I had also mentioned that it is the bond markets that drive other asset classes in any country.

The second part has stayed intact but the first part of this outlook fell flat on its face over the last 3 weeks. With higher interest rates imposed by RBI for overnight funding of banks and the Rollar kissing the 62 mark, Indian bonds are now trading with one of the widest gaps ever in the last 5 years. Whilst the coupon is 7.16%, the current yields in the money markets are over 8.6% and this is far worse than 2012 now. In 2012, the coupon was 8.16% and the highest yield over the counter was about 8.3% and the lowest around 7.8% In such a scenario, FMPs will be very very badly hit. [and they have suffered a lot of damage already]
Yesterday's fall can be largely attributed to the Rollar price and the surge in Indian Bond Yields.

Sentiments are extremely bearish and virtually every media outlet on tv or online is trying to attribute challenges to the US Fed decision of tapering QE. First and foremost, one must remember that tapering does not imply end of QE. All that the US Fed said was that it will review the situation and decide on the quantum of QE from the current USD 85 billion to some other amount. One must understand the key motivation factor for US as a whole - they want to ensure that the demand for dollars keeps surging at any given point of time. US has been following QE for over 5 decades now [since World War 2] i.e. printing money. This will go on forever, to the extend the world recognizes USD as the reserve currency of the globe. Names and forms will keep changing i.e. QE, Operation Twist, War on Weapons of Mass Destruction, Return of Democracy in Middle East etc etc etc - yes you heard it right. Even the so-called wars are nothing but a bid to prop up demand for dollars - period. So most people who will look at the US Fed decision on QE and take trading/investment positions accordingly IMHO will lose big time.

Markets are very well aware of continuous QE from US in all formats and hence in the larger scheme of things, it will be a non-event [there will be knee-jerk reactions in either direction of indices when press statements are released by FOMC]

The real game changer for Global Markets is actually the elections in Germany in 3rd week of September. That is something that nobody in mainstream media wants to talk about and the central bankers / politicians are happy to have it that way. Germany under leadership of Merkel has been bailing out Euro-zone countries for almost 6 years now without much respite. One should not forget that Draghi at ECB is literally powerless without green signal from Merkel to continue LTRO operations.

Merkel keeps saying in media that she is worried about tax payers' money being blown out but that bottom-line is that she is happy to go with the LTRO arrangement for now. Key motivating factor is that contrary to media reports, the fact is that Germany is heavily dependent on exports [both international and intra-Europe] The LTRO operations help German businesses big time. We have come to a stage where the nominal interest rates in Germany [for institutional deposits] is standing at -0.25% This means that to park money with the German central bank, the depositor has to pay interest to the bank!!! [of course the motivation behind this from investors is safety and a potential windfall gain should Germany return to DMs] also Germany's borrowing costs are lowest as a result of this kind of a setup.

Let us start with Merkel's current position and chances; German tax payers i.e. the middle class do not like Merkel too much right now. They feel that Merkel is siphoning off hard earned German tax money to peripheral European countries for simply too long. They are very clear that even billions of Euros as bailouts cannot actually change reality. Trillions and Quadrillions of Euros are needed for a full-fledged normalcy and this state can only be achieved by money printing. They fear the worst in such cases as Germany has gone through a very very hyperinflationary phase in World Wars where wheelbarrows of millions of DMs could barely buy a pack of milk and bread.

From the German business point of view, Merkel is 2nd only to GOD. She bails out nations and then her think tank ensures that most of the bailout money comes back to German corporates by means of tenders, business deals etc. They will offer thumbs up for her to continue at the helm. Until the election verdict is out, a lenient approach by ECB and Germany will continue as it is.

So things are not that hunky dory for the incumbents i.e. CDP in Germany. On the other hand, opponents of Merkel are hard-liners as far as economics is concerned. They are very clear that Germany must stop their version of QE [via bailouts] and restore the DMs. It is short-term pain for a long-term gain. Finland now is almost the defacto number 2 voice for the Euro-zone and Finland has been against bailouts after the 1st tranches were given off to Greece and Portugal.

Even if Merkel comes back, this time to ensure that she [or her party] continues, she will have to harden her stance and reduce bailout amounts. Should anti-incumbency come through, bailouts will be near zero! With the pain in Euro-zone worsening with more and more members joining PIIGS, Germany has approached a cusp moment of this era: Germany created the common Euro and rather than booting out so many members from the common Euro-zone, there is every chance that Germany might find it easier to work on its own exit and leave the PIIGS to decide further course of action.

To summarize, one need not look at US Fed [or BoE, BoJ for that matter] because demand for dollars will keep coming through. Germany is the game changer for global markets and stay tuned to that. Just to put things in perspective, the tactic currently used is similar to the tactics used by Japan during the Pearl Harbor explosion. Send one ship towards the west and let spies keep following that ship [equivalent of focus on US Fed today] send the real bombing ship eastwards to attack Pearl Harbor [what Germany will do] Japan also followed a similar strategy to outsmart Brits in Singapore when they captured Sentosa.

What Japan does as an excellent military strategy, Germany does so in economic wars. Be alert - learn where to focus without letting the media chronicles distracting you. They will always be late in reporting news as breaking news; the prudent and independent person uses his/her own discretion and directs focus to the core - the core for now is Germany

Clock is ticking tick-tock-tick-tock - Euro-zone break-up is inevitable; the only question is October 2013 or October 2016...........................................