RatecutinSK,StimulusinEuroandJapan

We wrote yesterday that the financial markets constantly alternate between the yin of Hope and the yang of Despair. Every news, whether it is financial, medical or geo political in nature, adds its weight to either of these two, and the market participants constantly try to recalibrate and reconfigure their bets with each incoming news item.

Let’s look at the important news items from yesterday. Firstly, the Euro area stimulus package of 750 bn Euro was released. The plan entails helping the economies which were hardest hit by the pandemic in a mix of grants and loans. The news eased the yields and credit spread for countries like Italy which are expected to benefit from the largesse. The plan is still to be approved through a complex process. To appreciate the complexity of the process it is necessary to understand the history and real politik of the current EU structure where the individual states have delegated monetary policy to the ECB but still remain in charge of the fiscal position of their countries. Raghuram Rajan in his book The Third Pillar writes extensively about the dilemma of the European states when they find the monetary policy set by the central authority is increasingly at odds with the fiscal requirement at home. Rajan writes that in the absence of the EU arrangement, when the individual countries were free to take decisions about the  currency and interest rates, they could have weathered any storm better by cutting rates and depreciating the currency. In the current case, any relief has to be approved by all the member states which is both time consuming and prone to bias. We saw one early manifestation of this during the debt crisis a decade back when acronyms (derogatory of course) like PIGS were coined. This time around the situation is expected to be better and debate is expected to be more sober as the crisis is pandemic induced. The Euro trades above 1.10 currently.

Contrast the above discussion with the stimulus response in Japan. The country plans add a further 117 trillion Yen (1.54 trillion USD) to an already extensive stimulus program. The intent and actions are synchronized and are not constrained by any morality deliberations.

In other news we had a rate cut announced by the central bank in South Korea. The rate cut of 25 bps now takes the policy rate to 0.5%. As per the statement by the Bank of Korea, the move was necessitated by the fact that the economy is expected to shrink for the first time in 22 years. We remember that the last time the South Korean economy contracted was in the heady years of the Asian financial crisis in 1997-98 where the sudden capital outflows impacted the entire region.

In other news, the statements by US Secretary of State on the Hong Kong issue represent an increasing hardened stance by the US but so far markets, especially equities, have taken this in their stride. The Dow Jones was up by close to 500 points in the trade yesterday. Asian stocks, with the exception of the Hang Seng, are also trading in the green.

Domestically, stock markets are up by close to 1% and the Indian rupee trades at 75.80 currently against the previous close of 75.72. On the bond market side we will today have the auction of 80000 Cr INR worth of CMBs with an 84 day maturity.