One of the outcomes of the US' federal structure is that the most powerful person in the world can be rendered helpless when dealing with intransigent domestic legislators. While this provides checks and balances on presidential power, it also results in occasional theatres of the absurd. Like at the moment, when the daily functioning of the US federal government has been shutdown by bickering over health care policy.
Warren Buffett thinks the brinkmanship between Republicans and Democrats "will go right up to the point of extreme idiocy, but we won't cross it". One fervently hopes that the Oracle of Omaha is correct. If the US Congress doesn't hammer out a compromise and manage to raise the debt ceiling, the US government could go into default. The consequences are difficult to extrapolate since this would be a Black Swan event. However, it would be very unpleasant.
Events on Washington's Capitol Hill have dominated headlines since the shutdown started. The US dollar has fallen and it could fall further while the deadlock continues. At least $300 million a day is being lost as a result. The losses will inevitably escalate if it continues. Estimates suggest that it could knock 0.9 per cent off US gross domestic product even if with quick resolution and the debt ceiling raised. The silver lining for traders is, of course, the extremely high probability that Quantitative Easing (QE) 3 will now continue. (Click for chart)
Run through two possible scenarios. In one, the deadlock will not be resolved. The US will default. There will be a global crisis and assuming markets don't freeze, bears will make a packet. This is low probability if only because every US legislator stands to suffer huge personal loss of net worth and political currency.
The second scenario is very high probability. A compromise will be worked out and the US Congress will vote to raise the debt ceiling. There will be a relief rally. The rally will be sustained when the Federal Reserve decides to continue QE3 at current pace after holding the October 28-29 Federal Open Market Committee meeting. Undoubtedly, there are multiple nuances within the second scenario. These will be analysed in detail by policy wonks but are more or less irrelevant for short-term traders.
Of course, the US shutdown isn't the only political issue affecting markets. Europe has status quo with Frau Merkel back in charge. Continuity is relief in this instance. In India, the Telangana issue could perhaps, cause a few ripples and the post-Diwali assembly elections in five states are now being touted as semi-finals.
The festive season will roughly coincide with Q2 results. The Reserve Bank of India (RBI)'s decision to open the tap for retail loans may help revive sentiment since this is when most consumers will do their annual buying. According to the HSBC Purchase Manager's Index, sentiment has been contracting now for three months and Puja-Diwali et al, is the best chance of turning things around.
Anecdotally, most corporations expect some improvement in Q2 results. The information technology (IT) sector and pharma, will be watched with great attention to detail, along with other exporters. The weaker rupee through Q2 should have pulled volumes and earnings up. Guidances will be even more important than actuals.
Infy starts the ball rolling this Friday when it declares results. Despite having lost ground in terms of marketshare and growth rates, this is still a bellwether with massive weight in free-float indices. There is already a speculative rally in IT stocks and in pharma, too, despite well-publicised issues with the US Food & Drug Administration.
On the macro-economic front, the current account deficit widened in Q1 (April-June 2013) to 4.9 per cent but it's expected to shrink sharply in Q2 when the rupee slid downhill. Exports grew in double digits in July and August and probably maintained growth momentum in September as well. Overall, legal imports may well have shrunk going by the drop in legal gold imports.
The rupee is safe enough now. While short-term external debt remains at high levels, rollover will not be a problem. Dr Rajan's new foreign currency non-resident swap scheme has also worked in that some $5 billion has come in via that route. While this is not officially part of reserves, it is useful.
The fiscal deficit remains at alarming proportions and so does inflation. I cannot remember a point in Indian history when government spending was significantly cut going into a general election. So, it's odds-on that the fisc will balloon some more. The food security Bill, the Seventh Pay Commission, a possible road sector bailout - do these moves signal an intention to cut spending?
Assuming QE3 continues at the current pace of expansion, the next RBI review will possibly cut marginal standing facility rates some more and raise the repurchase rate (the repo) a little, aligning rates back. The central bank has also carried out open market operations on a massive scale and may continue to do so, putting liquidity back into the system. This has resulted in an "untwisting" of bond yields with short-term yields dropping and long-term yields rising. The yield curve looks a little healthier.
Historically, October has tended to be extremely volatile and there are an alarmingly large number of imponderables that could move the market. Apart from the above, the NSEL imbroglio, which has been contained so far, could spiral out of control, if the MCX is hit.
Technically speaking, the Nifty is holding out at support near the 200 Day-Moving Average. There is no obvious short-term trend. Range trading could continue until there's some sort of news-based trigger. When that happens, the market may swing 5 per cent in a week. Option trader could consider wide strangles, buying short-term volatility. The long term still looks bearish.
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
