Growth, Inflation and Currency Dynamics
July 2022 saw change in narrative for global macros and financial markets. There were rising clamour for recession along with record high monthly inflation print. While the Central Bankers continued to remain hawkish, the markets now expect inflation and thereby policy rates to peak soon. This is clearly reflected in dollar strength (DXY), yields and commodity prices. Back home, the month was dominated by good monsoon (easing concerns about food inflation), moderating yet elevated inflation, currency pressures and rising concerns about external balances. Inflation continues to be key concern of policymakers, but slowly growth is taking a centre-stage.
June-22 Headline CPI came in marginally lower than consensus expectations (7.05%y/y). This will be second consecutive month of in line/marginally lower print (Jan-22 through Apr-22 print was higher than consensus). Core inflation came in lower at 5.96%y/y (Previous: 6.08%y/y). Favourable base effect and importantly lower than seasonal increase in food, housing and services prices helped in bringing down the inflation. Average 1Q FY23 inflation print stood at elevated 7.28%y/y (4Q FY22: 6.34% y/y; 1Q FY22: 5.6%y/y).
Globally, Inflation continued to remain elevated across countries driven by crude and food. In fact, in countries like US, UK, Euro area, it is ~9% levels and expected to remain at elevated level for rest part of CY2022. No wonder, despite rising concern about growth, the Central Bankers across globe have been aggressively raising rates to tame inflation expectations.
Clamour for the recession are rising worldwide and growth outlook is deteriorating. IMF, in its latest World Economic Outlook, has cut the CY2022 global growth by 40 bps and CY2023 by 70 bps, with broad-based downward revision in advanced and emerging economies. Pro-long War, broad-based inflationary pressures, front-loading of policy rate, tight financial conditions are likely to lead to moderation in growth. US economy contracted for second consecutive quarter in CY2022, raising concern of hard-landing. IMF has projected Indian economy to grow at 7.4% in FY23 (down by 80 bps from previous projections, yet better than RBI’s projection of 7.2%).
Persistently strong inflation has forced central banks globally to front-load and exercise larger hikes and withdraw surplus liquidity at faster pace. In July-22, US hiked the policy rate by 75 bps (225 bps hike since Mar’22) with indication to hike further over the next couple of meetings. ECB kickstarted its normalization process by hiking rate by 50 bps (higher than market expectations) with indication to do more. Bank of England is in midst of rate hike cycle and is expected to aggressively hike rate in upcoming meetings. That said, the general market expectations are of peaking of rate hike cycle soon for global central bankers. Easing Global supply chain constraints, deterioration in global PMI print & sharp fall in commodities indicates easing of prices pressures amid uncertainty.
India’s External Sector & Global Update
After a jump in June-22, July saw decline in crude prices on growth concerns. While commodities (including food) have been declining over last couple of months, crude prices declined for first time since Apr-22. While crude prices remain volatile over Russian soundbites, brent crude decline by 9%m/m in July. However, during YTD CY2022, crude rise has been very sharp (39%). Industrial commodities continued to decline in July, with most now below Dec 2021 levels indicating demand concerns.
In the bond markets, US treasury yields rose sharply across the curve in runup to policy on record monthly inflation print and expectation of hawkish policy. However, post policy, yield rallied on lesser than expectation hawkish Fed and rising growth concerns. The US 10 Yr Treasury bond yield started the month at 2.88% on rate hike expectation and rose further during the month to peaked at 3.04% ahead of policy and eased post policy to close the month at 2.67% on growth concerns. (June end: 2.98%, May end: 2.85%, Apr end: 2.89%, Mar end: 2.32%, Feb end: 1.83%, Jan 2022 end: 1.79%, Sep through Dec 2021: 1.5%-1.58% range). On risk -off scenario, Dollar Index strengthened (~3% m/m) in July and even crossed 108-mark mid-month. Post Fed policy it eased on growth concerns. YTD Dollar index has rose by ~12%.
Yield Levels & Spreads:
Taking global cues, yields remain volatile based on US treasury yield movement, DXY, arrival of monsoon allaying fears of food inflation, easing crude prices and rising global concerns of growth. 10-year G-sec started the month at elevated level of 7.42%, eased post inflation print, only to increase on currency pressure and rallied post Fed policy on recession concerns and DXY movement. It closed the month at 7.32 levels (June end close: 7.45%, May end close: 7.42%, Apr end close: 7.12%, Mar end close: 6.84%). 10 Term premia (10 yr over 365 days) eased further during the month to average ~120 bps (Jun: 133 bps, May: 166 bps, Apr: 238 bps, Nov-Mar: 222-228 bps range, Oct: 244 bps, Sep: 253 bps, Aug: 259 bps) indicating declining premium and curve flattening on changing RBI pivot.
Unlike G-sec, 10 yr SDL yields was range-bound and impacted by improved supply. It closed the month at 7.70% (Jun end: 7.78%, May end: 7.77%, Apr-end: 7.27%, Mar end: 7.18%). July SDL primary supply stood at Rs.52,990 cr (Jun: 42,500 cr, May: 57,740 cr, Apr: 10,000 cr). The spread between 10 yr SDL over G-sec stood at 33 bps (May-Jun: 29-30 bps, Apr: 21 bps, Feb -Mar: 35-37 bps, Jan 2022: 53, Dec 2021: 47).
AAA bonds yield were volatile during the month, although the underlying narrative was of decline in yields. 10 yr AAA PSU started the month at 7.89%, were volatile during the month and close the month at 7.70 lvls (Jun end: 7.89%, May end: 7.77%, Apr end: 7.35%, Mar end: 7.05%).
- Increasingly hi-frequency indicators globally (from growth, Purchasing Managers Index (PMI), trade to commodities) are indicating loss of momentum. This has led to rising concern about recession and likely peaking out of inflation and policy rates sooner than expected. While Central bankers will continue to focus on bringing down the inflation, the market expectations are building up of terminal rate might turn out lower than initially expected.
- Despite rising global uncertainty, RBI seems confident about the growth resilience based on hi-frequency data (like trade, tax collections) & RBI surveys (like capacity utilization, consumer confidence, business surveys). Regarding inflation, the inflation trajectory seems to have come down giving RBI some comfort on price front, although it has kept FY23 projections unchanged.
- In spite of getting comfort on inflation & growth front, August monetary policy was driven by concern over the external sector imbalances, which are likely to play key role in forthcoming policy on back of expectations of high FY23 Current Account Deficit (CAD) print and pressure on rupee.
- That said, we expect terminal rate ~5.90-6% - likely to be achieved by year end. In other words, 35-50 bps incremental hike in current cycle
- Core System liquidity has come down to 6 trn levels as of Jul 22, 2022 (down from peak 12 trn lvls as of Oct 2021) & overnight money market rates are around repo rates (unlike ~reverse repo rates during pandemic period). Going forward, currency in circulation, credit offtake and RBI’s action in forex market is likely to be decisive factor in determining overall core liquidity.
RBI, J P Morgan Research, US Federal Reserve, Bank of England, CEIC, MoSPI, CCIL, IMF
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