Deciphering the monetary moves

SMARTSHARE

The RBI's move to leave the repo rate unchanged on April 29 did give the markets a reason to cheer, which they did with the Nifty managing to close above its 200 DMA (daily moving average). But going forward,

Dr Reddy's sword will continue to hang over the markets, as a mere slide in crude may not help calm tempers frayed by inflation. The RBI is unlikely to change its hawkish stance unless the gauge tumbles comfortably below the 5 per cent mark.

The FOMC, the policymaking arm of the US Fed, reduced its target rate by 0.25 per cent to 2 per cent at the end of its two-day meeting on April 30, in a split vote, with two of the 10 members voting against any rate cut.

Both the quantum of the rate cut and the dissent were on expected lines. But the FOMC did not give a clear signal that it was through with its string of rate cuts that began with the September 18, 2007 meeting. The ambiguity gives the FOMC the elbow room to either cut, stand pat or even raise rates at its next meeting in the light of forthcoming economic data.

The FOMC's reluctance to stick its neck out is understandable. Last October, the Fed had declared that the risks of weaker growth and higher inflation needed to be balanced. This was a clear signal that the Fed did not intend to cut any further. But the wise men were forced to eat humble pie as soon as the credit crunch took a turn for the worse.

Irrespective of the FOMC's reluctance to spell out clearly its future policy, the Fed is almost done with its interest rate cutting spree. Barring a one-off 0.25 per cent cut if need be, as Friday's job data is not known at the time of writing, I don't think

Dr Bernanke will have to wield the scalpel again.

The US Q1 GDP managed to grow 0.6 per cent, against popular expectations of a de-growth earlier on, though economists were rightly expecting a 0.6 per cent growth. Though this rise would not have been possible without a 0.8 per cent growth on account of inventories, it gives some breathing space to Bernanke to hold his rate horses.

Combine the reluctance to cut with the Fed's known stance of going to any extent to help any panic stricken bank and you have a scenario where the dollar could strengthen. The dollar has begun appreciating against the euro and may give the greenback shorts a run for their lives.

The strength of the dollar could weaken commodities. The crude has shed $8 from its peak and gold too is weakening. A weak crude could help Bernanke fight inflation, but may not help Dr Reddy, though the import bill of the oil PSUs could be lighter. But it could also adversely impact the export competitiveness of US corporations, as more than 50 per cent revenue of the Dow stocks comes from exports.

How would markets behave in a strong dollar regime? Well, the software sector could harden and other export-driven sectors like gems and jewellery and textiles could breath a little easy.

A common belief is that as interest rates head northwards, markets should head south. This rule would hold true when the rates are changing orbits. But in the current scenario, where they are not going to run away too far, the markets are unlikely to be in a hurry for a southern sojourn though they may do so for altogether different reasons. If the markets do tank later, it will be on account of the still high gearing of the banks and not rising rates.

In the US, the markets begin to rise before the interest rates bottom and begin to fall before the rates peak. The record from 2000 to 2008 shows just that. In fact, markets and interest rates travel in the same direction for most of the distance. This phenomenon may not allow participants to convincingly participate in an upward rally.