Global
In our last newsletter we stated that our focus over the next few months would be Europe/UK due
to our belief that if there is a negative event then it would likely emerge from here. Since then, the
UK govt and Chancellor of the Exchequer have made several missteps in their mini budget (the
higher rate of tax reduction has already been rolled back) which sent sterling spiralling down and as
bond yields rose the Bank of England had to step in to buy bonds to protect pension funds from
collapsing. All eyes are on Europe where rumours continue to circulate around a major investment
bank being in trouble. Maybe this is just the trailer to further problems ahead as European and UK
central banks raise interest rates further over the next few months.
Federal Reserve officials continue their hawkish rhetoric with respect to bringing down inflation
through further rate hikes. The one change is that they will also look at the jobs data to confirm that
their measures are working. We are concerned on this as jobs data will likely be a lagging indicator
and therefore the FED runs the risk of keeping rates higher for longer than required. They also
mentioned that they need compelling evidence of disinflation before changing course.
Our overall view is that inflation will likely tick down from here but would still be far away from the
FED’s target of 2%, maybe getting to 4-4.5% over the next 6 months. Maybe this will lead to a less
hawkish stance from the FED (other central banks will follow suit) and lead to a rally in equity and
bond markets. In the short-term though the risk of unintended consequences of raising interest
rates will keep the markets volatile. The fact that the global economy is heading towards recession is
known but a financial problem is not.
Such hawkish Fed amid slowing global growth is causing turbulence in global asset markets with
unprecedented volatility in global currency, bond and equity markets. This may continue for some
time.
Domestic
Unlike western world India is relatively better placed both on growth as well as inflation. This is
reflected in relative outperformance across asset classes be it bonds, currency and equity. Coming
quarter also augurs well for domestic growth driven by private consumption and government
spending.
RBI hiked by another 50bps, which was on expected lines. It noted that growth impulses are
broadening and hence it has upgraded its H2FY23 real GDP growth forecast. Interestingly, this
monetary policy acknowledges the risk from global central banks action. This raises terminal policy
rate consensus assumptions. On the inflation front, it retained its FY23 forecast of 6.7% with risks
being largely balanced.
Divergence between domestic and external recovery are now visible. Domestic high frequency data
remains very strong as seen in car sales (>20% YoY in Q2FY23), credit growth (9 year high), GST
collections up 26% YoY, record home registrations. However, exports are slowing down, which in
turn is weighing on industrial trade and activity. Global slowdown could weigh on some segments of
growth in Indian economy and could increase external vulnerabilities.
Concerns on the macro-stability front started inching up in India. CPI inflation has started to
moderate, but still remains elevated at 6%+ for fourth consecutive month in August. Trade deficit is
consistently high and this along with hawkish Fed is resulting in pressure on INR. Higher credit
growth, RBI defending currency is draining banking sector liquidity – which has slowed from Rs 8tn in
April to ~Rs 0.5tn in September. This led to significant rise in short term rates impacting funding cost.
On the flows front, FIIs became net sellers again in September to the tune of USD1.4bn, after being
net buyers in previous two months. DII flows turned positive to USD1.8bn in September, after
outflows in August.
Deployment strategy
The bullish market sentiments of July and August has reversed in September with Nifty correcting by
3-4%. The month was a very eventful one with central bank actions, both global and domestic and
growth datapoints.
Going ahead, outlook is mixed. On the positive side, domestic growth is finally perking up and
getting more broad-based. Further, commodity prices are now easing, which should lower the
inflationary pressures and potential RBI tightening. Also, bank balance sheets are now strong and
banks are finally focussing on growth rather conserving capital. However, global growth has slowed
down decisively and unlike past, central banks still remain hawkish. This could weigh on growth
outlook and valuations multiple going ahead. Valuations too are still on the expensive side, despite
the de-rating seen over the last year. We stay selective in our deployment levels as we expect global
volatility to remain very high.