The Indian market goes up higher in booms, falls harder in downturns and rallies more during pullbacks. It’s what analysts call a high beta market. Proof of that may be seen from the current market rally, although it could be argued that the Reserve Bank of India’s (RBI) recent actions and the government’s pressure on banks to reduce lending rates have helped. That was clearly seen from the late rally on Tuesday, with the real estate and banking sectors moving up sharply.

More importantly, interest rate cuts in many countries and the determination of central banks to throw whatever they have at the credit markets is finally having an effect. Three-month dollar Libor has gone back to levels prevailing before the Lehman Brothers bankruptcy, levels that prevailed practically unchanged between April and mid-September. The Vix for the US markets, a measure of volatility also known as the fear gauge, was down to 53.1 on Monday, well below the record high of 89.5 it scaled on 24 October. The TED spread, or the difference in yields between three-month US deposits and three-month treasury bills, another measure of the “flight to safety" is down to 2.37%, compared with 4.64% on 10 October. The EMBI+ index, which measures the spread of emerging market bonds over US treasuries and is, therefore, another indicator of risk appetite, which had spiked to 857 basis points on 23 October, is now back at 585 basis points. The panic is behind us.

At the same time, the credit markets are a long way off from where they were even a few months ago. The EMBI+ spread, for instance, was below 300 at the beginning of August. The TED spread was at 1.14% in early September. And the Vix was below 20 in late August. Note also that US three-month T-bill yield continues to be a very low 0.48%. All this may not be a bad thing, implying that there’s still a lot of scope for risk appetite to improve. That could provide additional fuel to the current bear market rally.

Of course, everything could reverse rapidly if another bank teeters on the brink, as we have seen before. And bear market rallies are usually followed by a retesting of earlier lows. The markets will now start to price in the effects of a deep and prolonged global recession. As Morgan Stanley economists Stephen Jen and Spyros Andreopoulos point out, “While the financial markets may be experiencing intense effects of ‘deleveraging’ (that is, shrinking of balance sheets by investment banks and hedge funds), real money accounts such as pension funds, life insurance companies as well as sovereign wealth funds that don’t use leverage will also be likely to start to liquidate their holdings. The two concepts are distinct and the timing of the two waves of sales of risk assets is likely to be asynchronous, we suspect. Especially in EM (emerging markets), we believe that there will be further waves of liquidation of positions from EM, as the global economy slows."

Also, in spite of the recent RBI announcements, note that three-month Mibor is still at 11.87%, only slightly below last Friday’s level of 12.07%. While this may be a reflection of the fact that all the RBI measures are yet to take effect, it does indicate the extent of the cash crunch.

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