Global
The Federal Reserve’s 75bps interest rate hike and the move towards becoming more data reliant was not a surprise to us as outlined in our last newsletter. We anticipate the FED to "pause/stop" hiking interest rates around October 2022. This was the good news we were looking for but we feel the market may have got ahead of itself in the short-term. Indeed, the narrative has changed to "bad news is good news". The reason behind our caution is that we think the market is overlooking the prospect of a global recession and implications for corporate earnings. Since the last economic recession (around 2000), most downturns have been financial in nature and from 2008 onwards the central bank’s response has been to throw money at the problem leaving liquidity sloshing around. We have already mentioned of the unforeseen consequences of tightening previously, and we would be monitoring high yield debt spreads as the FED raises rates again in September and increases the amount of balance sheet reduction.
What really concerns us though is the fact that with minimal hikes, which usually take six months to feed through to the economy, the US economy is already in a "technical" recession. So, by the time data shows up on how rapidly the economy is contracting it will be too late, and all the FED can do is pause/stop rate hikes and maybe look to ease in 2023. In our view, it will not be able to consider QE as politically this would be seen as unacceptable with inflation running high and with most economists targeting inflation of around 5% going into 2023. That said, we still believe that "deflation" will be the dominant theme as we close the year.
A key positive of the above is that the dollar may weaken going into 2023 as the impact of the recession starts to play out and the market factors in the lower rates. This should also give emerging markets like India an opportunity to follow suit. Hence, our ongoing and more constructive view that foreign investor flows will return as they look for pockets of economic growth.
Over the next two months we expect US housing and jobs data to be poor and this will likely bring the market back to the reality that "bad news" is indeed a bad news.
India
While US is in “technical recession" but on the domestic front, the high frequency data are shows improving trend. GST collections, continue to remain strong in July at INR 1.5tn (+30% YoY). Apart from this, manufacturing PMI was healthy (at 8-month high), along with improvements in core sector growth, and auto sales. Credit growth is finally showing signs of an uptick (inflation effect). Thus, while global growth is slowing down, domestic growth remains quite strong.
While growth is strong, macro-vulnerabilities are also rising. CPI inflation continues to remain elevated at 7%+ for the third consecutive month in June. Most of the growth parameters are inflation linked and hence, may moderate if high inflation persist for a longer term. Also, high trade balance along with hawkish Fed is resulting in pressure on INR. As a result, theRBI is using forex reserves to defend the same. This is leading to draining of banking sector liquidity,which has declined from INR 8tn in April to less than INR 1 tn in last fortnight of July.
FII outflows slowed significantly to ~USD 0.2bn in July (vs. last 6 months’ average of USD 5bn). This is the slowest pace of FII outflow since October 2021. DII flows were relatively resilient at USD 1.3bn.
Quarterly earnings were not disappointing but were mixed. Actual demand and outlook were stable across sectors – both domestic as well as export oriented ones. However, margin pressures continued to dampen the sentiments. Domestic demand risk will rise i as global slowdown starts impacting domestic growth. While demand concerns are yet to crop up, earnings were downgraded by ~2-3%.
On the monsoon front, while it is overall adequate, 5 key states are still under deficit and those are important states from an agriculture produce perspective.
Deployment Strategy
A broad based domestic growth, easing commodity prices and a healthy and growing banking system makes us positive on the domestic recovery story. But outside India, global growth slowdown is visible with central banks’ still hiking rates. Slower global growth could potentially cloud India's growth outlook and expose external vulnerability. India market valuations post last month’s rally are again moving towards the expensive territory. Hence, we are taking calibrated approach towards portfolio deployment. We stay very selective.