Hawkish Central Bankers, Financial market Volatility amid rising uncertainty
Month saw pick-up in inflation, resilient global growth with rising recession concerns, hawkish Central bankers (with some planning to reduce the speed of increase) and rise in financial markets volatility (G-sec, currency). In India, month saw higher than expected inflation print, pressure on currency, high trade deficit and robust fiscal print.
September CPI Inflation rose to 7.41% y/y (Previous: 7%y/y). This was higher than seasonality. Adverse Base effect, higher food prices (festive season demand, lower supplies due to erratic rains), clothing and fuel prices pushed up the headline print. Similarly, core inflation rose to 6.07% (Previous: 5.84%). Unlikely last month, the sequential trends were mixed, with higher than seasonal rise in food, clothing (due to supply pressures, festive season demand), while fuel, housing and services price increase lower than seasonality. Average 2Q FY23 inflation print stood elevated at 7.04%y/y (1Q FY23: 7.28% y/y, 4Q FY22: 6.34% y/y).
Although, expenditure growth showed an acceleration in September, 1H 2022 fiscal deficit continued to remain at low levels - aided by robust revenue receipts (tax as well as non-tax). Both revenue expenditure and capital expenditure was buoyant in September. October GST data indicates that GST collections continued to remain robust during festive season.
Trade deficit has worsened since start of the fiscal year, driven by moderation in exports (complete ban, export duties, export quota) and jump in import due to strong domestic demand & high acceleration in crude prices. Latest month print, however, indicates some improvement in trade balances, aided by improvement in exports and moderation in imports. With Sep trade (good and services) print available, 2Q current account deficit (CAD) is likely to be in the range of 4.5%-5% of GDP, with entire year print expected to be in range of 3.5%-3.8% of GDP (much above RBI’s comfort levels of 2.5%).
After witnessing net FPI inflows in July-Aug, Sep-Oct saw marginal outflow of FPI (cumulative US$0.8bn) reflecting rise in volatility in global financial markets.
While RBI has been intervening regularly in forex markets, adverse external imbalances were reflected clearly on exchange rate movement over last couple of months. Rupee depreciated sharply in Oct by 2.63% m/m and even breached 83 mark for short period on strong dollar bias. Average Rupee was ~82.34 during the month (Sep: 80.23, Avg July-Aug: 79.55-79.59, Jun: 78.07, May: 77.27, Mar-Apr: 76.09- 76.26, Jan-Feb: 74.44 -74.95). YTD CY2022 rupee depreciated ~ 11% against dollar. That said, Indian rupee has been resilient vis-à-vis other emerging economies in CY2022 YTD.
Yield Levels & Spreads:
Yields were volatile during the month, with intra-month movement linked to domestic inflation, crude prices, rupee, dollar index and global financial market volatility. From trading in range of 7.08-7.39% in Sep, 10-year G-sec moved up and were in range of 7.37%-7.52% in Oct. It closed the month at 7.45 levels (Sep end: 7.39%, Aug: 7.18%, July: 7.32%, June: 7.45%, May: 7.42%, Apr: 7.12%, Mar: 6.84%).
10 Term premia (10yr over 365 days) eased further during the month to average ~58 bps on account of shorter end of yield curve rising faster than the longer end (Sep: 77 bps, Aug: 104 bps, Jul: 120 bps, Jun: 133 bps, May: 166 bps, Nov 2021 - Apr 2022: 222- 238 bps).
Like G-sec, 10yr SDL yields inched up and remained high throughout the month. It closed the month at 7.76% (Aug-Sep: 7.52-7.57%, May through Jul: 7.70-7.78%, Apr: 7.27%, Mar: 7.18%). Sep SDL primary supply stood at Rs.70,450 cr (May-Sep 22 monthly average ~50,000 cr, Apr 2022: 10,000 cr). The average spread between 10yr SDL over G-sec stood at 29 bps during the month (Sep: 28 bps, Aug: 35 bps, May-Jul: 29-33 bps, Apr: 21 bps).
Taking cues from G-sec, AAA bonds yield also inched up and remained range-bound during the month. 10yr AAA PSU started the month at 7.79%, reached 7.84% by mid-month, only to ease a bit to close the month at 7.76% (Sep end: 7.76%, Aug end: 7.51%, Jul end: 7.7%, Jun end: 7.89%, May end: 7.77%, Apr end: 7.35%).
Inflation continues to remain at elevated levels across countries, while Sep print indicates marginal decline in US, it rose further in Europe and UK. In fact, after moderating a bit in July-Aug, inflation in both advanced & emerging economies has inched up driven by food and fuel prices. Inflation is expected to remain much above global central bankers’ comfort level in near term, the Central Bankers across globe have been aggressively raising rates to tame inflation expectations.
While recession concerns are rising, latest US, China and UK GDP data for Sep quarter shows growth continues to be resilient. That said, US Fed Sept dot plot indicated that US growth is expected to be flattish in CY2022, only to rise marginally to 1.2% in CY2023. Europe and UK are expected to go in to recession in coming quarters. China’s CY2022 growth has been aggressively revised down by IMF. Prolong War, broad-based inflationary pressures, aggressive synchronised front-loading of policy rate across globe, tight financial conditions are likely to major headwinds to global growth in coming quarters.
Persistently strong inflation has forced the central banks globally to front-load and exercise larger rate hikes and withdraw surplus liquidity at faster pace. The trend continued, with ECB and US both hiked the policy rate aggressively by 75 bps in recent policy meeting. Federal Reserve Chairman Powell sounded hawkish in recent policy, reiterating that inflation continues to remain primary focus. With most of rate hikes in current cycle already done, US Fed policy statement signalled to reduce the speed of rate increase in coming meetings depending on evolving data. ECB, however, sounded dovish despite hawkish hike - driven primarily by growth concerns. With Inflation under control and rising growth concerns, China is expected to remain dovish. With many economies across globe (advanced and emerging) closer to terminal rate in current rate hike cycle, many central banks have pivoted to slower increase in policy rate in recent times.
After sharp rise in yields in Sep, US treasury yields continued to rise further with intermittent volatility. The US 10Yr Treasury bond yield started the month at 3.67%, cross 4% mark by mid-month on inflation print and rose further to touch intra-month high of 4.24% by third week, only to come down to close the month at 4.10% - driven mainly by dovish policy-makers statement. (Sep end: 3.83%, Aug end: 3.15, July end: 2.67%, 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%).
Reflecting this sharp jump in yields, Dollar Index continued to strengthen further. It rose by 1.14%m/m during month after rising sharply by 3.3% m/m in Sep. Intra-month, it even breached 113 mark, only to close the month at 111.53 (Sept end : 112.11) YTD Dollar index has rose by ~16.5%.
Financial markets, which were spooked by UK government’s fiscal profligacy announcement, received respite in form of new Chancellor and Prime Minister, with both promising rapid fiscal consolidations.
- With inflation likely peaking in September ’22, the inflation is expected to come down in 2H aided by base effect, seasonality and demand moderation.
- However, inflation may be expected to remain above 6% for most part of 2H, keeping RBI on vigil. Further, Fed hawkish stance, rupee pressure and external balance concerns will keep RBI nimble footed. Growth resilience (as evident in high-frequency indicators) gives headroom to RBI to remain inflation vigilant.
- That said, after front-loading and hiking aggressively, we expect RBI to reduce the speed of rate increase in coming meetings since most of the rate hike in current cycle is already done.
- On fiscal front, strong revenues receipts in 1H FY23 and robust nominal growth will likely help in achieving FY23 fiscal deficit target, despite rise in additional expenditure on various items (from subsidy to MNREGA - Mahatma Gandhi National Rural Employment Guarantee Act 2005). Further, we don’t expect any additional G-sec borrowing in 2H.
RBI, Finance Ministry, Bloomberg, CEIC, CCIL, Crisil, ICRA, BoE, US Federal Reserve, ECB, PBoC
Disclaimer:The information herein is meant only for general reading purposes and the views being expressed only constitute opinions and therefore cannot be considered as guidelines, recommendations or as a professional guide for the readers. The document has been prepared based on publicly available information, internally developed data and other sources believed to be reliable. The sponsor, the Investment Manager, the Trustee or any of their directors, employees, associates or representatives (“entities & their associates”) do not assume any responsibility for, or warrant the accuracy, completeness, adequacy and reliability of such information. Recipients of this information are advised to rely on their own analysis, interpretations & investigations. Readers are also advised to seek independent professional advice in order to arrive at an informed investment decision. Entities & their associates including persons involved in the preparation or issuance of this material shall not be liable in any way for any direct, indirect, special, incidental, consequential, punitive or exemplary damages, including on account of lost profits arising from the information contained in this material. Recipient alone shall be fully responsible for any decision taken based on this document.