Currency Corner by Kotak Securities

Dollar Demise - A False Narrative !!!

As a market watcher we all have grown with the view that whenever there is uncertainty in world, be it economic, political or geo-political, everyone rushes to safe heaven asset i.e. dollar.

But last week, what happened after Trump announced tariff, upended the multi-decade old convention - market instead of seeking refuge to dollar and US bonds safety, rushed to other assets like gold, euro (german bonds), Swiss franc and Japanese Yen. One has to see the outsized move in these assets to see the panic.

No wonder, as a result, dollar index slumped below 100 and US benchmark bond yield saw the wildest move in a week since 2001, from 4.20 to 3.85 to 4.58 to close at 4.49.

In a market size of $29 trillion, such a wild move can easily scare anyone, including US president and we saw Trump blinking. But the way bond yields moved yesterday despite Trump pivot on tariff for non-retaliatory countries, it seems, market wants Trump to blink again.

Will he blink again or not, only Trump knows but one thing is sure, world is not going to be same.

Humanity in modern history, possibly, enjoyed the most prosperous time in last 40/50 years, riding on globalisation and unprecedented growth in international trade. US dollar and its safe heaven status played a critical role in its growth by standardising the nuts and bolts of global trade and creating a whole eco-system around it- right from trade invoicing to secured shipping lines to FX reserves to a liquid and deep capital market for fund raising, to everything that needs to support cross border trade.

It will be very difficult for a single country to carry this burden, unless we are ok with higher frictional cost and a fragmented multi-lateral trading eco-system.

Coming to US, while market chatter is filled with dollar gloom and doom, countries pulling out money from US bonds etc…but question is, what next? Where these countries can park all the funds? As per one of the reports, total foreign ownership in US equities, bonds and credit market is $18.5, $7.2 and $4.6 trillion respectively.

Can Switzerland or Japan or Germany or gold (preferred safe heaven assets right now) absorb $30 trillion of assets without letting their domestic currency and economy impacted, esp when everyone will be desperate to find alternative to US, to exports. Answers will not be easy.

Further, how countries will service or re-finance their dollar debt, running in trillions, with a broken international trading system. The only way for a country to earn dollar is through exports. Given that except for US, no other country can print dollar, it is not going to be easy for them either.

We have seen in past how dollar has behaved with liquidity tightening. We may get into similar situation except that right now, market is focussed more on one side of the narrative looking at price action.

But just to give the perspective, in early 2020 as well, when COVID hit, we saw similar move in dollar index from 101/102 to 90, before recovering all the way to 113. I am not suggesting that it will play out same, but ignoring the well-entrenched role of dollar in global financial system and trade can be a big mistake.

So, as much as reset on international trade is going to be painful for US, dollar and bond, so will be to players sitting on other side of equation with dollar debt. The whole narrative on dollar demise can change with Trump blinking again. He has blinked once and hence can blink again.

We’ve been reiterating for months now that the real story is the US-China trade and economic war. Everything else is a derivative—a subplot in the larger drama. Think of it like a messy divorce: the US and China are the bride and groom, and the rest of the world? Just the relatives caught in the crossfire.

For de-dollarisation to truly take root, de-globalisation must precede it. And for de-globalisation to play out meaningfully, a hard economic decoupling between the US and China is inevitable. Only then can regionalism thrive in its full form.

We’re living through the slow but seismic shift of an 80-year-old world order. These are fascinating times, where the tectonic plates of global power, trade, and currency are quietly but surely moving.


Disc: https://www.kotaksecurities.com/disclaimer/commodities - Kotak Securities

China says it will ignore the US if tariffs keep escalating

The US Dollar Index is grappling with a crisis of confidence. Policy uncertainty, particularly the erratic shifts in external and trade policies under the Trump administration, is accelerating the dual forces of de-dollarisation and de-globalisation. Markets are increasingly pricing in the likelihood of deeper interest rate cuts by the Federal Reserve to support a weakening US economy, adding to the pressure on the dollar.

Since November last year, our view has remained consistent: the "America First" policy framework is emerging as a catalyst for de-dollarisation through de-globalisation, and potentially marks the end of an era of American hyper-consumerism. We had also anticipated a hard decoupling in US-China trade relations — a trend that now appears to be firmly underway.

While a potential escalation in trade tensions may offer short-term support to the dollar against BRICS+ currencies, we believe that over the medium to long term, the US administration and the Federal Reserve may actively pursue a weaker dollar. The objective: to restore export competitiveness and rebalance trade.

Over the next 12 to 24 months, we expect coordinated policy efforts aimed at weakening the dollar meaningfully from current levels as part of a broader strategic reset in US economic policy. It may come at the cost of a much higher inflation over the long run and higher longer term yields

A New and Bold RBI under New Governor !!!

Generally, central bank policy meeting are like religious days for market participants where they all carve out time to listen what financial market god (read governor) has to say. But some meetings turn out to be special, where god gives more than what everyone prays for, and yesterday’s meeting was no less than that.

In central banking, communication is an important tool and different governors across the world have used it to their advantage. But Mr. Malhotra not only used it to his advantage but also for market participants clarifying on growth, liquidity, real rates, FX intervention, change in stance etc.

Lets start with

1) Growth

Mr. Malhotra clearly elucidated that in present growth-inflation dynamics, growth is a bigger concern, and we are ready to work with govt to support growth. Not only this, he went on to add, growth is also important for capital flows.

Please note, a central bank which has clear mandate to target inflation, it cannot be more explicit than this.

2) Liquidity

When asked on system liquidity, governor clearly said that central bank would like to maintain sufficient liquidity for proper policy transmission, and as a reference point, one can consider a ball-park number as 1% of NDTL, which roughly comes to 2.5 lac crs. Again, he cannot be more explicit than this.

He further added, as a central bank, he would not like to anchor liquidity to 1%, and if needed, it can be higher, as well as lower, depending upon market situation. Today, system liquidity is in surplus to the tune of 1.3 lac crs, after being in deficit for more than 3 months and infusing more than 6 lac crs liquidity.

3) Real Rates

According to governor, as per various studies, real rates should be between 1.1% to 1.9%, hence 1.5% can be considered as a good reference point.

With RBI having given inflation forecast of 4% for FY26 and repo rate at 6%, in my view, one can fairly assume that another 50 to 75 bps cut is possible.

4) FX Intervention

As per governor, Indian market is fairly liquid and deep and RBI would like to intervene only during excessive volatility.

Again looking at two way move being allowed in rupee in last 3 months - from 84.50 to 88 to 84.90 to 86.80 and now 86.30, it can be fairly construed that RBI will not mind move in rupee so long as it is not idiosyncratic and move is in line with domestic and global development.

5) Stance

Yesterday RBI changed its stance from neutral to accommodative. But at the same time, governor clarified that accommodative means, absence any shock, only two possible outcome - a rate cut or statu quo.

It was a big clarification for market as it can be sure now that no rate hike possible until there is change in stance. No wonder, bonds saw a decent rally post this to 6.45.

In nutshell, if one reads though all the points, it clearly sends the message that RBI not only want to support growth but also want to keep the communication clear.

So what does this mean for bond market?

A huge positive. I will not be surprised if bond yields soften to as low as 6% or even lower, in next 3-6 months.

Nothing can be more supportive for any market than a dovish central bank with clear communication. Had their been no noise on tariff and jump in US bond yields in morning, Indian bonds could have seen even stronger rally. But more important is direction, and it is clear - heading downward.

Trade War is Not Over Until it is Fixed with China !!!

In cricket, we say that match is not over until the last ball is bowled. In same way, one cannot say that concern around trade war is over by giving a reprieve of 90 days.

It is very difficult for anyone to figure out how supply chain and inter-connectedness on trade front will pan out, sans China; given the fact that it is world’s largest merchandise exporter for most of products.

Moreover, no one knows how China is going to play out, after it increased the tariff on US to 84% and in turn US pushed to 124% on China.

Will it come for negotiation with US, or play a game of attrition because it knows that Trump has to answer its citizens and not the other way round. Further, so far, Chinese financial market, mainly FX or bonds has not reacted as violently as seen in US.

There are talks around that Trump pivoted yesterday as US bond yields spiked violently during Asian markets to 4.50+, triggering different rumours, ranging from basis risk blowing up, to some Asian central bank selling bonds to build defence for their currency.

Remember, one of the main objectives of tariff, was also to bring the bond yields lower so that US can roll-over its debt at lower yield, besides using the tariff to fix trade balance and possibly negotiate with countries to switch to longer duration bonds. But unfortunately, market has another way to look at things.

Equity was expected to react negatively and hence most of experts within Trump administration talked about, it is time for main street and not wall street, but possibly got it wrong on bond yields when instead of moving lower, it turned the other way, forcing Trump to PIVOT.

How bonds can be so powerful, one need to read the comments made by James Caville, Clinton political advisor - I used to think that if there is reincarnation, i wanted to be come back as president or the pope. But now, i would like to come back as the bond market. You can intimidate anyone.

Coming back to topic, given the insane level of tariff between world’s largest importer and exporter, it cannot be said as tariff or trade war any longer, but trade embargo, and there is famous saying by French economist - where trade does not flow, army does.

Not implying that anything remotely to it can happen on ground, but damage to global trading system/order and in turn to economies, will be no less.

It is way too difficult for anyone to figure out how in this inter-connected world, who is swimming naked. We saw a glimpse of it post COVID, when global supply chain got broken putting many countries in grade situation, or Germany faced its worst economic crisis with sudden stoppage to Russian natural gas. Trade inter-connectedness with China is no different, in my view.

Good part is there is some chatter of US and Chinese leaders ready to discuss on tariff. Hope it gets momentum but until then it is time to be extremely agile with sharp focus on risk management. Tactical bounce back along with fast changing situation can be a big sucker. However, amidst all the chaos, noise and trust deficit, precious metals look to stand tall.

Test

Potential Impact on Iran’s Oil and Gas Production During a Conflict with Israel



In the event of an all-out war between Iran and Israel, Iran’s oil and gas production and exports could face significant disruptions, with wide-reaching implications for the global energy market.


Oil Disruptions:


Key Infrastructure Vulnerability: Iran's major oil export terminals, such as Kharg Island and Sirri Island, are critical to its export operations. These could be prime targets in a conflict, potentially halting up to 1.6-1.7 million barrels per day (bpd) of crude oil exports. Damage to these facilities could dramatically reduce the country's ability to supply oil.


Refining and Storage: Attacks on refineries in Bandar Abbas or Abadan could cripple Iran’s refined product exports, which contribute 240,000-300,000 bpd to its total oil-related exports.


Strait of Hormuz: This vital shipping lane, through which 20% of the world’s oil passes, could become a focal point of the conflict. Any disruptions here would not only impact Iran but also global energy supplies.


Gas Disruptions:


Pipeline Vulnerabilities: Iran's major gas export pipelines, such as the Tabriz-Ankara pipeline to Turkey, could be targeted. This pipeline carries 9-10 bcm/year of natural gas, a significant share of Iran’s total exports.


Domestic Gas Supply: The South Pars gas field, which powers much of Iran’s domestic energy needs, could also be disrupted, impacting 1 bcm/day of natural gas production, leading to power outages and industrial slowdowns.


Total Potential Disruption:


Oil Exports: Up to 100% of Iran's crude oil exports (1.6-1.7 million bpd) could be jeopardized.


Gas Exports: Around 17-20 bcm/year of natural gas exports, especially to Turkey and Iraq, could be halted.


Domestic Supply: Iran’s internal energy consumption could also suffer due to damage to key gas fields and refineries, causing widespread energy shortages.


This potential disruption would have significant consequences not only for Iran but for the global energy market, especially if conflict escalates to affect the Strait of Hormuz.


(anindya.banerjee@kotak.com)

China’s grand plan to revive its economy hinges on a fundamental miscalculation: the idea that sparking a bull market will magically boost domestic consumption.


Here's the problem: Chinese households are already under immense financial strain, squeezed out of the nation’s $20 trillion GDP pie like they’re not even invited to the table. And let’s not forget, domestic consumption as a share of GDP is directly tied to households' share of national income—which, by the way, is abysmally low for a country of this size. It’s hard to fuel an economy on spending when households are barely scraping by.

After years of disastrous investments in failed private lending schemes, bank collapses, and a property bubble that burst with all the subtlety of a detonated minefield, it's no surprise households are reluctant to open their wallets.


The government's corporate crackdowns only further eroded confidence, leaving households squeezed even more.

So, what's Beijing’s brilliant idea? Instead of fixing the root problem—actually transferring wealth from corporations and the government to the people—Chinese policymakers think they can kick-start consumption by inflating stock prices and hoping for a "wealth effect." Because apparently, who needs real money when you can just make people feel rich, right?


This stimulus package is woefully vague on any real wealth redistribution mechanisms. Instead, it’s all about optics—put the cart before the horse, inflate stock prices, and see if households magically start spending.


After all, nothing screams "financial stability" like an artificial bull market. What could go wrong?

Of course, the influx of foreign money is fueling this delusion for now. But when the cash tap inevitably dries up, both local and foreign investors will find themselves in a high-stakes game of musical chairs, where most are guaranteed to lose.

And, as usual, households, the very group that should have been at the center of economic policy, will be left holding the bag.

If this is China’s grand economic strategy, they might as well start printing "Pipe Dreams of Prosperity" on their next set of stimulus checks.


~~ anindya.banerjee@kotak.com