Wednesday, November 30, 2011

The Fed's steroid shot

Yesterday, the US Fed announced measures to inject liquidity into the European banking system, which has been desperately short of dollars over the last couple of months. Equity markets rallied, and the dollar dropped, prompting energetic buying of gold.

As Mohammed el Erian said, risk markets love liquidity injections. Makes me think of those who mainline heroin, and of quacks who give patients steroid injections when they don't have the ability or willingness to tackle the underlying malaise.

In this case, the underlying chronic ailment is the massive debt under which European governments are labouring, and the escalating price at which they have to finance this debt. Investors across the world are increasingly reluctant to buy European government securities, underlined by these numbers from a Reuter's report: "Globally, the bonds allocation to the euro zone fell to 26.9 percent from 27.4 percent. But this masked a much greater U.S. and UK retreat. U.S. investors moved to 17.6 percent from 19.1 percent and British counterparts sliced their exposure to just 8.9 percent from a previous 11.9 percent." *

Making more cash available to the European system is not going to make this debt any more attractive; cheap dollars will help banks temporarily square off their books, but a Eurozone in recession doesn't suggest that the struggling European governments will be able to service their debt without a massive readjustment.

Here, for example, is speculation about an upcoming Spanish bond auction:

The Fed's move smacks of desperation, and I wonder how many hours of trading the buoyancy will hold out.
For India, it had the immediate effect of kicking New York crude above 100 dollars; when our commodity markets closed last night, crude oil December futures were above Rs. 5200 per barrel, the highest they've been this year; if the rupee remains depressed, our Finance Minister will have to go back to the Parliament, asking for a supplement to the supplementary budget to finance the losses of the Oil Marketing Companies. This, of course, will not be a great signal for Foreign Exchange markets, which will bid the rupee down further.. etc.

Meanwhile, with our GDP growth rate slipping to 6.9% (and I suspect we have a ways to climb down yet), the India growth story is acquiring a somewhat tatty look. I suspect a de-rating of our PE multiples is around the corner, as soon as the euphoria of the Fed steroid shot wears out.

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