Jamal Mecklai: What was that bearded man thinking?

Last Updated: Thu, Feb 09, 2012 19:41 hrs

One of my market gurus recently told me, “There are two things that you don’t fight — you don’t fight liquidity and you don’t, in general, fight central banks.”

Given this, it is easy to explain the rupee’s recent seemingly relentless rise. With the European Central Bank (ECB) committed to providing oceans of liquidity to keep the continent’s banks alive and the sovereign debt crisis from boiling over – and now, since the last FOMC meeting, the Fed continuing its “money for nothing” policy — it seems futile to argue against taking on risk.

In the five weeks since the start of 2012, foreign institutional investors have pumped $6 billion into Indian equity and debt markets, and the rupee has reacted — smiling its way through 50, then 49 to the dollar. Gold is holding comfortably above $1,700 and most other commodities have a spring in their step.

The dollar is wilting — the DXY dollar index even slipped (temporarily?) below 79, and looks distinctly soft. There appears to be little solace for this getting-nervous dollar bull.

So, what is the story? Is this a return to business as usual, meaning a forever weak dollar, or is it simply the correction to separate the true believers from the fly-by-nights?

To be fair, my reasoning for dollar strength – like most market stories – is hardly built on the most solid of foundations. No trend goes on forever, and the dollar index had been falling for nearly 10 years. When it fell below parity on the Australian dollar, something in me said, “This is too much.” And while my timing was wrong – that happened last February – my instinct was correct.

The dollar turned in early September, carrying all, including gold, before it. By this time, it was also becoming apparent that the US economy had lived through the (ha ha) near-depression and a turnaround was on the cards. Indeed, the employment numbers turned in November – in the last three months, unemployment has fallen by more than a percentage point, to 8.3 per cent – and there is now considerable anecdotal evidence suggesting that US businesses and, indeed, the US consumer are getting back to business.

So, why this Kolaveri Bernanke? Why is he saying he will keep interest rates near-zero till the end of 2014?

That’s more than two years away and, with due respect to Fed’s information collection and analysis, nobody can see that far ahead. And, of course, nobody believes it can. So, why make a statement that risks putting you on a par with S&P, and renews the license to investors to buy, buy, buy risk assets, like equities, emerging market currencies and commodities.

If, indeed, the Fed does leave rates at these levels, it is certain as night follows day that global inflation will start to climb, which may explain why gold is shrieking loudly.

This would have difficult repercussions for most emerging economies, notably India, where the Reserve Bank is just beginning to breathe a little easier on inflation. If oil and other commodities remain high – perhaps, even rise further – we may be a long time waiting for the manna of lower interest rates. And if Indian – and other emerging market – growth disappoints, the incipient US recovery could also get nipped in the bud.

Granted, like most sensible people, the bearded man would probably like to see Obama get re-elected, and, perhaps, the promise of forever cheap money will encourage more hiring on the ground in the US — no president has been re-elected if the unemployment rate is higher than eight per cent. But this goal, if indeed that is part of the reasoning, could equally be achieved by simply keeping rates low without making such a loud statement about it.

While using zero returns to coax companies with huge cash surpluses to take risk may work to a point, it is generally well documented that, for the real economy, continuously lowering interest rates is like pushing on a string. The dangerous flip side is that such a policy can quite quickly push American consumers back into their destructive negative savings habit. And most frighteningly, if he is wrong while being so far out on a limb, it could trigger yet another round of mayhem in markets, perhaps worse than the last two.

Coming back to my market guru, “The illness of excess first bubbled over in the US mortgage securities market; the ocean of liquidity response pushed the problem under, but in less than two years it resurfaced more viciously in the sovereign debt crisis in Europe. Now, a renewed tidal wave of liquidity is suppressing the problem yet again. Will the next explosion be in emerging markets?”

By all means, drink at the fount of liquidity, but be very, very careful.


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