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Are markets headed for another 2008?

We will know soon enough whether the huge sell-off in the markets on Thursday was capitulation

Mumbai: The S&P BSE Sensex plunged 3.4% on Thursday, bringing the benchmark index close to its lowest since 9 May 2014.

The fall was part of the global sell-off that has been in evidence since the beginning of the year.

The Sensex is now down 12% from its January opening.

The latest panic in the markets was triggered by Bank of Japan governor Haruhiko Kuroda’s decision to go in for negative interest rates. The move seems to have been part of Kuroda’s Peter Pan approach to central banking. In June last year, he had quoted from J.M. Barrie’s Peter Pan, ‘‘the moment you doubt whether you can fly, you cease forever to be able to do it."

Chart 1 shows the announcement of negative interest rates had unintended consequences, with the yen soaring high and the US dollar falling from around 121 to the yen to below 112 on Thursday. USD-JPY is a barometer of risk aversion and the yen strengthened as the markets started worrying whether central banks knew what they were doing.

Interestingly, the chart also shows the near perfect correlation between the drop in USD-JPY and the Sensex.

Investor George Soros has said that the present scenario is similar to 2008. Few agree, but there’s little doubt that concerns about China, worries about US interest rate policy, nervousness about the impact of negative interest rates on banks, and qualms about the dive in commodities and the lack of growth make for a toxic mix.

Others point out that while central banks had a bazooka to tackle the financial crisis, they now seem to be shooting blanks. Not that this is 2008 redux, but Chart 2 shows the similarities between how 2016 has panned out so far for the Sensex and how it fared at the beginning of 2008.

We will know soon enough whether the huge sell-off on Thursday was capitulation. The markets are now looking to the European Central Bank’s Mario Draghi to keep his promise of more stimulus and to Kuroda to push down the yen.

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