7/27/2019 facts on US debt ceiling

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One of the outcomes of the US’

federal structure is that the mostpowerful person in the worldcan be rendered helpless when dealingwith intransigent domestic legislators.While this provides checks and balanceson presidential power, it also results inoccasional theatres of the absurd. Likeat the moment, when the daily func-tioning of the US federal governmenthas been shutdown by bickering overhealth care policy.

Warren Buffett thinks the brinkman-ship between Republicans andDemocrats “will go right up to the pointof extreme idiocy, but we won’t cross it”.One fervently hopes that the Oracle of Omaha is correct. If the US Congressdoesn’t hammer out a compromise andmanage to raise the debt ceiling, the USgovernment could go into default. Theconsequences are difficult to extrapolatesince this would be a Black Swan event.However, it would be very unpleasant.

Events on Washington’s Capitol Hillhave dominated headlines since theshutdown started. The US dollar has fall-en and it could fall further while thedeadlock continues. At least $300 milliona day is being lost as a result. The losses

will inevitably escalate if it continues.Estimates suggest that it could knock 0.9per cent off US gross domestic producteven if with quick resolution and the debtceiling raised. The silver lining for tradersis, of course, the extremely high proba-bility that Quantitative Easing (QE) 3 willnow continue.

Run through two possible scenarios.In one, the deadlock will not be resolved.The US will default. There will be a glob-al crisis and assuming markets don’tfreeze, bears will make a packet. This islow 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 beworked out and the US Congress willvote to raise the debt ceiling. There willbe a relief rally. The rally will be sus-tained when the Federal Reservedecides to continue QE3 at current paceafter holding the October 28-29 FederalOpen Market Committee meeting.Undoubtedly, there are multiplenuances within the second scenario.These will be analysed in detail by pol-icy wonks but are more or less irrele-vant for short-term traders.

Of course, the US shutdown isn’t theonly political issue affecting markets.Europe has status quo with Frau Merkelback in charge. Continuity is relief inthis instance. In India, the Telanganaissue could perhaps, cause a few ripplesand the post-Diwali assembly electionsin five states are now being touted assemi-finals.

The festive season will roughly coin-cide with Q2 results. The Reserve Bankof India (RBI)’s decision to open the tapfor retail loans may help revive senti-ment since this is when most con-

sumers will do their annual buying.

According to the HSBC PurchaseManager’s Index, sentiment has beencontracting now for three months andPuja-Diwali et al, is the best chance of turning things around.

Anecdotally, most corporationsexpect some improvement in Q2 results.The information technology (IT) sectorand pharma, will be watched with greatattention to detail, alongwith other exporters. Theweaker rupee through Q2should have pulled volu-mes and earnings up. Gu-idances will be even more

important than actuals.Infy starts the ball

rolling this Friday when itdeclares results. Despitehaving lost ground interms of marketshare andgrowth rates, this is still abellwether with massive weight in free-float indices. There is already a specu-lative rally in IT stocks and in pharma,too, despite well-publicised issues withthe US Food & Drug Administration.

On the macro-economic front, thecurrent account deficit widened in Q1

(April-June 2013) to 4.9 per cent but it’s

expected to shrink sharply in Q2 whenthe rupee slid downhill. Exports grew indouble digits in July and August andprobably maintained growth momen-tum in September as well. Overall, legalimports may well have shrunk going bythe drop in legal gold imports.

The rupee is safe enough now. Whileshort-term external debt remains at hi-

gh levels, rollover will notbe a problem. Dr Rajan’snew foreign currency non-resident swap scheme hasalso worked in that some$5 billion has come in via

that route. While this isnot officially part of reserves, it is useful.

The fiscal deficitremains at alarming pro-portions and so does infla-tion. I cannot remember a

point in Indian history when govern-ment spending was significantly cutgoing into a general election. So, it’sodds-on that the fisc will balloon somemore. The food security Bill, theSeventh Pay Commission, a possibleroad sector bailout — do these moves

signal an intention to cut spending?

Assuming QE3 continues at the cur-rent pace of expansion, the next RBIreview will possibly cut marginal stand-ing facility rates some more and raise therepurchase rate (the repo) a little, aligningrates back. The central bank has also car-ried out open market operations on amassive scale and may continue to doso, putting liquidity back into the sys-tem. This has resulted in an “untwist-ing” of bond yields with short-term yieldsdropping and long-term yields rising.The yield curve looks a little healthier.

Historically, October has tended tobe extremely volatile and there are an

alarmingly large number of imponder-ables that could move the market. Apartfrom the above, the NSEL imbroglio,which has been contained so far, couldspiral out of control, if the MCX is hit.

Technically speaking, the Nifty isholding out at support near the 200Day-Moving Average. There is no obvi-ous short-term trend. Range tradingcould continue until there’s some sort of news-based trigger. When that happens,the market may swing 5 per cent in aweek. Option trader could consider widestrangles, buying short-term volatility.

The long term still looks bearish.

Why October will make or breakHistorically, October has tended to be volatile and there are an alarmingly large number of imponderables that could move the market

FRONT RUNNING

DEVANGSHU DATTA

 Assuming QE3continues at thecurrent pace of expansion, the nextRBI review will

possibly cut marginalstanding facility ratessome more and raisethe repurchase rate(the repo) a little,aligning rates back

 Value--------------------------------------------------------------------------------------------------------------------------------------

20 Sep Current(Oct4) Change %NiftyValue 6012.1 5907.3 -1.74

IndexPE 17.47 17.32 -0.86Index dividend yield 1.47 1.56 6.12Index Book value 2.88 2.81 -2.43USD INR (RBI Refrate) 62.23 61.44 1.27

FII netbuys/ sales(Oct1-4)# 11176.05* 1431.61

DII netbuys/ sales(Oct1-4)# -9130.07* -669.72

# ~crore, * = Sep 1-30 net buys/ sales

NO SHORT-TERM TREND

Support at 200day movingaverage

       R       E       U       T       E       R       S