We talked to leading economists and fund managers to help you make sense of what is happening in the US and how it could impact emerging economies like India. This is what Dhawal Dalal, EVP and Head of Fixed Income at DSP BlackRock Mutual Fund, had to say:
Do you see a possibility of a US debt default?
For now, the financial markets are not factoring the possibility of a default. The financial markets expect both the Democrats and the Republicans to come to some sort of conclusion to increase the debt ceiling. But in case there is a default, then the implications for financial markets could be very high. There has not been much rise in yields in the US but I think that there will definitely be some rating action so the credit rating may get impacted. The last time when the US rating got downgraded, there was a massive rally in the US bond market but this time around I don't know how the markets would react but there would be high levels of volatility and we would like to position ourselves for preservation of capital before all these issues.
What will drive the financial markets ahead?
We are now sure that elections will happen in April-May. Elections are very important factor given out that market participants may actually figure out which party is likely to win and what policies they have in mind that would kick-start the economic activity and growth. The Budget may come in June-July and after that there will be monsoon. So basically the real economic activity may perhaps begin to take shape by September 2014 onwards.
Any concerns that could take the markets down in the near term?
There are a number of things that could go wrong in today's market that could result in the change in sentiment of market participants. First, is the geopolitical risk. For now the crisis in the middle-east has taken a backseat as diplomatic efforts are gaining momentum. Sudden re-emergence of geopolitical risk could push price of crude oil and change the sentiment at a short notice. Second, is the softening of growth impulse in the global markets-incoming data is giving confidence to market participants that global financial markets are healing. However, if one looks carefully beneath the data, it gives a sense of fragility. A further increase in interest rates or an event risk such as US default could change this picture at a short notice.
What advice would you give to our readers in these times?
Exercise caution and prefer safety and liquidity over yield in the current market scenario. The credit environment continues to remain challenging. We expect more credit downgrades than upgrades. The current credit spread is relatively tight and not commensurate with the risk of underlying credit risk. Moreover, the current levels of money market yields offer better risk-adjusted returns in our opinion. Based on these factors we advise investors to focus more on quality and safety of their portfolios and invest in short duration funds.