Oil prices at multiyear highs and rate hikes by ECB and the People’s Bank of China are more positive than negative for equity markets. High oil prices signify prospects of good economic growth across the world while rate hikes by central banks lead to carry trades that find its way into risk assets including emerging equities.
The market behavior in the time of oil prices ruling at multiyear highs and rate hikes by major central banks highlight the positive sentiments prevailing in the market at present. Oil prices closed last week at highs for the week, with Brent crude closing last week at USD 126.5/bbl and Nymex crude closing at USD 112.8/bbl.
Oil prices have risen by 6.5% week on week. However, equity markets closed in positive territory week on week despite rising oil prices. The Sensex, Nifty, DJIA, Nikkei, Kospi and DAX all closed last week with marginal gains while Hangseng closed last week with a 2.5% gain.
Rate hikes by the ECB (ECB raised rates for the first time since 2008 last week) and by the People’s Bank of China (PBC raised rates for the second time this calendar year) caused the Euro and the Yuan to close last week at multiyear highs. The Euro closed last week at Eur 1.44 to the USD while the Yuan closed at CNY 6.53 to the USD a week on week gain of 1.7% and 0.20% respectively.
Rising oil prices must be looked at in conjunction with the broad weakness in the USD. The USD index (DXY), which is the index of the value of the USD against a basket of major world currencies, touched its lowest level since January 2010 last week.
The index has fallen by over 7% in the last one year. The weakness in the USD in conjunction with a rise in equity and commodity prices signals bullish asset markets. The World equity index (MSCI) has gained over 11% in the last one year while the Reuters CRB commodity index, which is an index of a basket of commodities has gained over 33% in the last one year.
The trend of falling USD and rising asset prices is looking to continue for a while. The reason for the USD weakness is that the US Federal Reserve (Fed) is likely to be the last Central Bank in the world, leaving out Bank of Japan to raise policy rates. The Bank of Japan is unlikely to raise rates for a while given the economic consequences of the natural disaster that took place in March.
The Fed is holding on to a loose monetary policy while other central banks across the world (except Bank of England and Bank of Japan) have commenced policy tightening. Inflation has been the key driver of policy tightening by central banks across the world. Inflation has been trending at higher than desired levels in many countries including the Euro Zone, China, India, Brazil and Russia. The USD has become the defunct funding currency given the near zero rates in the US and the rising rates in other countries.
FII’s will continue to come into Indian equities given the broad trend of USD weakness against strengthening emerging currencies. Hence rising oil prices and policy rate hikes is seen in a more positive than in a negative light. In fact the market will have to worry when there is a trend reversal of USD strengthening and asset prices falling. However, that will come about when the Fed turns hawkish and that does not seem to be their calling as of now. Â
