A rupee strategy

Having hard-currency assets overseas can be fruitful if the rupee falls

Trading patterns in the bond markets are often a better indicator of economic health than equity trading patterns. Large chunks of the global economy have had negative yields for years and yield curves have recently started inverting as well.  These are both causes for concern. Indeed, yield curve inversions are supposedly among the most reliable signals of recession. 

Japan and the Eurozone have had negative yields for years. That indicates economic activity has been persistently low across regions that contribute roughly a quarter of gross domestic product (GDP).  Negative yields occur when consumption is low and these are usually triggered when a central bank deliberately sets a negative policy rate. (This may be nominally negative, or it may be lower than the inflation rate.) 

The negative policy rate induces commercial banks to set low, or negative rates. That means it literally costs money to keep savings in the bank. It is a sign that policymakers want people to spend money to stimulate activity, via consumption or investment.  

A yield curve is a comparison of returns from sovereign debt instruments across different tenures. Logically, if you lend money for two different tenures, to the same entity, you should get a higher return for the longer tenure.  That is a positive yield curve and the normal state of affairs. 

Since hard currency sovereign debt is low risk, such instruments are traded constantly in the global bond markets, indicating excellent price discovery. We know that there is something wrong if the yield curve for such instruments is inverted. That means investors are prepared to accept a lower return from a longer- term instrument.  

It indicates they are expecting trouble in the short term and looking for a higher short-term return to offset higher risk.  Even a flat curve – where the long-tenure return is the same as short-tenure return – is considered a danger signal.  The last time US treasuries showed such patterns was during the subprime crisis. 

The traditional benchmark for yield curves is specifically two-year US government debt versus ten-year debt.  The dollar is the default global currency and US government debt is the safest instrument in the world. The yield curve on these two bonds has inverted momentarily several times in the past year and it has now stayed inverted through the last week. The inversion is visible across other tenures as well.  This is a sign of an impending recession.  

The trade war with China is one reason why the US economy may be slowing or going into reverse gear. Since early 2019, the earning per share estimates of the S&P 500 has been downgraded several times, from an initial projection of 7.5 per cent growth in 2019 to about 2.2 per cent.  China is also slowing, with its lowest GDP growth numbers in many years.  

Recession in the US will certainly trigger downturns across the global economy. The subprime crisis led to a global recession when India for instance, suffered GDP growth contraction. The Nifty fell more than 50 percent in 2008. 

Every global trader is now eagerly waiting for the US Federal Reserve (Fed) to move into rescue mode.  The Fed has alr­e­ady cut rates.  It could re­vert to quantitative easing (QE), buying bonds to release money into the market. The European Central Bank and Japan are already doing QEs.  In that case, the flood of easy money could lead to a sudden surge in equity prices, including rupee equity prices.  

An American QE is not unlikely.  But the price volume response to opening the fiscal taps may not necessarily be the same as in 2008-09. The geopolitics of 2019 are different, thanks to the trade war and Brexit and a general hardening of attitudes against immigration, which prevents free flow of labour and goods.  

Given India's huge exposure to trade, the impact of a global recession would be severe.  There are some investments worth investigating as hedges in an already difficult environment.  Gold remains a haven in times of stress and the precious metal could continue a bull run. 

A second possibility is an “anti rupee" stance. Assume the rupee will lose more ground.  In that case, exposure to hard currency assets overseas could pay off in rupee terms, even if those assets lose value in dollar terms.  Investors should look to diversify in this way.