Ultra-Hawkish Central Bankers, Sharp rise in financial market Volatility and rising uncertainty
Sep’22 saw elevated inflation prints, ultra-hawkish Central bankers, recession concerns and more importantly sharp rise in financial markets volatility (from g-sec, equity, commodity through currency). Fiscal profligacy announcement by UK government towards end of month resulted in sharp rise in risk-averseness.
In India, inflation, monetary policy hike came in line with consensus expectations. With Current Account Deficit (CAD) print coming better than expected, robust fiscal and non-core imports numbers, growth seems to be holding strong. Rupee performance has been resilient, supported by RBI
Aug-22 Headline Inflation rose to 7% y/y (Previous: 6.71%y/y). This was in line with seasonality and in line with market expectation. The core inflation rose marginally to 5.84% (Previous: 5.78%). Low Base effect and higher seasonality in food pushed up the headline print. Sequential momentum remained sticky (from June through August) at 52 bps. Average YTD FY23 inflation print stood at elevated 7.11%y/y (4Q FY22: 6.34% y/y; Apr-Jul FY22: 5.6%y/y).
RBI has begun front-loading the rate normalisation process since Apr 2022. War, record high inflation (global & domestic), ultra-hawkish global central bankers & external balances (Read: record high trade deficit & currency pressure) have necessitated RBI’s change in pivot. Sept policy was step forward in that direction and also in line with consensus expectations. In the meeting held in Sep-22, MPC hiked the policy rate by 50 bps to 5.9%. Like Aug-22 policy, Sept’s actions were driven mainly by external sector concerns. YTD, RBI has effectively hiked the policy rate by 190 bps since May 2022. RBI also revised down FY23 growth projections to 7% (Previous: 7.2%), while keeping inflation projections unchanged.
April-August 2022 fiscal deficit stood at record low levels driven by muted expenditure growth and robust tax receipts (direct as well as indirect taxes). While revenue expenditure was muted, capital expenditure has been buoyant since start of the year. September advance tax and GST collections data indicates that tax collections continued to remain robust in 1H FY23.
India’s External Sector & Global Update
1Q FY23 CAD rose to 2.8% of GDP (previous: 1.5%) on back of high trade deficit and outflows from primary income account, while services and remittances continued to remain buoyant despite global headwinds. Although first quarter witnessed high outflows from FPI account driven by global risk-averse environment, strong FDI flows, robust banking capital and short-term credit help in keeping BoP positive (US$4.6 bn).
That said, latest trade data continued to indicate further deterioration in trade balances, with monthly trade deficit in range of record high US$28-30 bn. Strong domestic demand, high crude prices and restrictions on exports (complete ban, export duties, export quota) are key drivers for sharp jump in trade deficit. There are growing concerns about current account deficit, with consensus now expecting FY23 CAD in range of 3.5%-3.8% of GDP (much above RBI’s comfort levels of 2.5%). These external balances are already reflecting on rupee and RBI has been intervening regularly in forex markets to reduce volatility of currency movement.
After witnessing net FPI inflows in July-Aug, September’22 saw marginal outflow of FPI (US$0.44) bn driven by equity flow.
Tracking strong dollar and ultra-hawkish Fed, Indian rupee continued to remain under pressure. Rupee which was tracking below 80 lvls before Fed policy, rose sharply and was on average 81.41 lvls post policy. Average Rupee was ~80.23 during the month (Avg July-Aug: 79.55-79.59, Jun: 78.07, May: 77.27/US$, Apr: 76.09/US$, Mar: 76.26/US$, Feb: 74.96/US$, Jan: 74.44/US$). YTD CY2022 rupee depreciated by 9.8% against dollar. That said, Indian rupee has been resilient vis-à-vis other emerging economies.
Yield Levels & Spreads:
Yields eased during the first half of the month on expectations of bond index inclusion & lower crude prices, rose post Fed policy and thereafter post RBI policy. 10-year G-sec started the month on positive note at 7.18%, eased to 7.08% by mid-month, harden to 7.31% post Fed policy and 7.39% post RBI policy.
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 ~77 bps on shorter end of yield curve rising faster than the longer end (Aug: 104 bps, Jul: 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).
Like G-sec, 10 yr SDL yields eased in the first half and rose post policies (Fed and RBI) during the month. But unlike Gsec, the volatility in yields was much lesser. It closed the month at 7.57% (Aug end: 7.52%, Jul end :7.70%, Jun end: 7.78%, May end: 7.77%, Apr-end: 7.27%, Mar end: 7.18%). Sep SDL primary supply stood at Rs.53,591 cr (Aug: 59,526 cr, Jul: 52,990 cr, Jun: 42,500 cr, May: 57,740 cr, Apr: 10,000 cr). The average spread between 10 yr SDL over G-sec stood at 28 bps during the month (Aug: 35 bps, May-Jul: 29-33 bps, Apr: 21 bps, Feb -Mar: 35-37 bps, Jan 2022: 53, Dec 2021: 47).
Taking cues from G-sec, AAA bonds yield eased initially, only to rise further post Fed and RBI Policy. 10 yr AAA PSU started the month at 7.51%, eased during the month to 7.45%, rose post Fed policy to 7.71% and RBI policy to 7.76%. (Aug end: 7.51%, Jul end: 7.7%, Jun end: 7.89%, May end: 7.77%, Apr end: 7.35%, Mar end: 7.05%).
While inflation continues to remain at elevated levels across countries, the pressure points are slowly coming down barring Europe and UK. Commodity prices (crude, industrial to food) have come down from record peak since mid-June on recession concerns. That said, the inflation is expected to remain much above global central bankers’ comfort level over long period. No wonder, the Central Bankers across globe have been aggressively raising rates to tame inflation expectations.
Recession concerns are rising. US Fed dot plot indicates 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 on frequent lockdown, property market issues. Prolong War, broad-based inflationary pressures, aggressive front-loading of policy rate, tight financial conditions are likely to major headwinds to global growth.
Persistently strong inflation has forced central banks globally to front-load and exercise larger hikes and withdraw surplus liquidity at faster pace. In Sep’22 policy, US Fed asserted to remain ultra-hawkish, with dot plot indicating terminal Fed rate at record high 4.6% (prior: 3.8%). ECB has already indicated that 50 bps hike is on the table, while BoE will have to continue with its rate hike cycle to control spiraling inflation.
After a jump in 2022 May-June, July through Sep saw decline in crude prices on global growth concerns. Brent crude decline by 9%m/m in Sep (July-Aug: -ve 9.4%). This in turn has helped in bringing down YTD CY2022 crude price rise to 11%. Since April, Food prices have come down sequentially and in August stood in single digit first time since CY2021, on improved supply.
In the bond markets, US treasury yields rose sharply across the curve during the month on ultra-hawkish Fed and elevated monthly inflation print. The US 10 Yr Treasury bond yield started the month at 3.26%, rose during the month ahead of policy, jumped by ~20 bps post policy, only to close the month at 3.83% on hawkish Fed. (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%, Sep through Dec 2021: 1.5%-1.58% range). Reflecting this sharp jump in yields, Dollar Index strengthened sharply by 3.3% m/m in Sep’22 to close the month at 112.12
YTD Dollar index has rose by ~16%.
Larger than expected fiscal sops announcement by UK government towards the end of the month resulted in sharp rise in UK g-sec yields and sharp depreciation of pound.
- Despite rising global uncertainty, RBI, in Sep-22 policy, seems confident about the growth resilience. Based on RBI’s fan chart, the inflation trajectory seems to have come down, giving RBI some comfort on price front, although it has kept FY23 projections unchanged.
- Sep-22 policy was driven by concerns over the external sector imbalances, which is likely to play key role in forthcoming policies on back of expectations of high FY23 Current Account Deficit (CAD) print and pressure on rupee. Given the global dynamics, we expect terminal rate ~6.25-6.50% - likely to be achieved.
- Going forward, we expect shorter end of the curve (upto 5 yrs) to tend to outperform. Reason: Terminal rate of 6.5% and liquidity tightness is already baked in at shorter end of curve. Further, due to hawkish global central bankers, the major brunt of upward revision of rates has been borne by shorter end of curve over last couple of months and hence yield curve was flattish. We expect the yield curve to steepen from here. Shorter end of the curve looks attractive in terms of absolute carry.
- Entire yield curve has already factored in 6.5% terminal rate. Therefore, future rate hikes are likely to have limited impact. Volatility (due to global factors) may continue going into future, yet adverse impact is likely to get cancelled out, since current market pricing has well-price most of the uncertainties.
RBI, Finance Ministry, Bloomberg, CEIC, CCIL, Crisil, ICRA, BoE, US Federal Reserve, ECB
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