Market may remain edgy

The president of the European Central bank, Jean-Claude Trichet, on Monday last called on oil producers and consumers to learn from past mistakes if world economies were to avoid a repeat of the high inflation and unemployment that followed the first global oil shock in 1973.

That year is widely acknowledged as an economic watershed, a time when an OPEC oil embargo led to a spiral of higher prices, recession in world economies and a wrenching contraction in the early 1980s that finally put an end to a decade of sharp inflation.

No one, whether the consumers or oil suppliers, would want to repeat that history, Trichet said, adding there is a joint interest in behaving as properly as possible. In the entire South-East-Asia, policy-makers are facing their toughest economic challenge in a decade — surging inflation and slowing down of growth.

The governments are yet to embrace the proven micro-economic policy response — aggressive monetary tightening. Instead, they are favouring stop-gap administrative measures such as price caps on essential commodities, based on, probably, an inappropriate logic.

In fact, with today’s price surge being seen as temporary, over-reacting to it could undermine the already weakened economic growth. Asian central banks are sitting on the fence. The scenario has an uncanny similarity with the US situation in the 1970s. The markets witnessed a bloodbath last week, with both the Nifty and the Sensex touching their lowest-ever levels in 2008.

The weak sentiment was mainly driven by extreme negative global cues seen both in the US and the Asian markets against the backdrop of a sharp rise in global crude prices. Also RBI’s action of hiking the repo rate by 25 bps in the middle of the week contributed to the negative market sentiment, as indications of a marginal interest rate hike in the near term are now getting confirmed.

Global crude oil prices witnessed further volatility and a sharp rise last week on the back of a weakening dollar and news reports that supplies could get further hit in the coming months as Nigeria — a major oil producer — was likely to see supply constraints due to labour unrest.

With oil prices unlikely to cool down in the near term, this is certainly a bad news for the Indian markets, as this will have a direct impact on India’s trade deficit because almost 70% of the crude oil requirements is still imported.

However, some good macro news at the weekend included a strong IIP growth for April ’08 at 7%, as compared to 3.9% in March ’08, beating analyst forecasts which had projected the IIP growth target at 5.6%. This boosted market sentiments moderately and the increase was largely aided by a strong growth coming in from the manufacturing sector and in particular a pick-up seen in the capital goods sector.

The outlook for the next week continues to remain negative and volatile. This is because despite the sharp sell-off seen in the broad indices last week, the overall leveraged positions in the market on the F&O side continue to remain high and are a matter of concern going ahead. The markets have convincingly failed to rise and most stock rallies have proved to be short lived.

A major concern would be the current week’s inflation number which is likely to touch around 10% since this will factor in the petrol, diesel and LPG price increases. How the government manages to cool off inflation in the coming days will be keenly awaited by the markets. More importantly, the repo rate hike of 25 bps is just one of the tools the RBI has initiated to curb inflationary pressures in the economy and many more measures may be rolled out before the next review policy on July 29, 2008.

More specifically, although small intermediate rallies are not ruled out, the markets have clearly not made a decisive bottom and some more pain could be left before the markets stabilise and a clear uptrend begins.

via Economic Times