Nifty slips on negative global cues and the concern of faster RBI tightening

Looking ahead, jumbo Fed hiking and elevated domestic inflation may force RBI to continue to follow the Fed hiking path and RBI may hike +0.50% on 30th September

India’s benchmark stock index Nifty closed around 17327.35 Friday; tumbled almost -1.72% on negative global cues and the concern of faster RBI tightening. Nifty stumbled over -300 points from the opening session high of 17639.30; following Dow Future, after the European market opened and the new U.K. Government unveiled £45B worth of fiscal stimulus in the form of various tax cuts despite double-digit inflation. The bond yield on both sides of the Atlantic soared, while stocks slumped.

In its maiden ‘mini budget’, the new British Government slashed stamp duty, income tax, the bankers' bonus cap, and tax on the very richest 660K Brits to rejuvenate the economy, which is already under huge stagflation. On Friday, the new British Truss Government (Chancellor Kwarteng) canceled almost all the tax hike measures by his predecessor Sunak.

As a result, British 10YBond/Gilt Yields surged to almost +3.80% Friday, the highest since 2010 from +3.50% the day before, while GBPUSD sinks to around 1.09947, the lowest since 1985. The latest British stimulus plan includes the cancellation of a planned rise in corporate tax to 25%, keeping it at 19%, and a reversal in the recent 1.25% rise in National Insurance contributions.

The measure would include scrapping the 45% top rate of income tax and replacing it with a 40% rate and a cut in stamp duty on home sales. The UK Debt Management Office said it was raising its debt issuance plans for the current financial year by £72.4B, reflecting the funding required for all measures announced by the new finance minister. Meanwhile, borrowing costs reached 14-year highs for other short-dated British government bonds: 5-year yields broke above 4%, and both 3-year and 7-year ones approached 4%.

The British/Truss government estimates the tax cuts will total £45 billion by 2026-27, but the market is concerned that public debt levels will soar; at a time the economy is already under big downward pressure. The Bank of England (BOE) on Thursday hiked interest rates BY +0.50% for a seventh straight time to combat double-digit inflationary pressure, with policymakers saying they would continue to ‘respond forcefully, as necessary to return inflation to the 2% target sustainably, despite the economy entering recession/stagflation.

On Friday, the US10Y bond yield also jumped to almost +3.75%, while the USD (US dollar index) jumped above 112, the highest since May’2002. Subsequently Wall Street tumbled as higher bond yield; i.e. higher borrowing costs and also higher USD is negative for stocks, especially MNCs (exporters).

Further, better than expected U.S. PMI data released Friday strengthen USD as Fed has no problem with further jumbo tightening in the coming months. Subsequently, Dow Future sinks to around 29300, almost at 52-week low levels. India-50 Future (SGX Nifty) also made a low 17124.00 before closing around 17197.00.

Overall, the Nifty slid around -2.43% and stumbled almost -800 points from the recent high of 18094.20 primarily on negative cues from Wall Street amid the concern of faster Fed tightening and an all-out synchronized global stagflation/recession.

Further, on Monday, the Nifty tumbled -1.80% to close around 17016.30 after making a low 16979.10 after the GBPUSD flash crashed in early Asian sessions, hitting a record low after UK chancellor Kwarteng vowed to pursue more tax cuts. Subsequently, British bond yield soared and British Pound tumbled along with Dow and other stock/index Futures. Importantly, if British Pound falls to parity with the US dollar, it could trigger a rebellion among Tory backbenchers who could refuse to vote for the government’s finance bill or even submit letters of no confidence in PM Truss, causing more political and policy uncertainty.

On Monday U.S. session, GBPUSD again slumped, while USD surged and Wall Street Futures stumbled after a dovish statement by BOE Governor:

“The Bank is monitoring developments in financial markets very closely in light of the significant repricing of financial assets.

In recent weeks, the Government has made a number of important announcements. The Government’s Energy Price Guarantee will reduce the near-term peak in inflation. Last Friday the Government announced its Growth Plan, on which the Chancellor has provided further detail in his statement today. I welcome the Government’s commitment to sustainable economic growth and the role of the Office for Budget Responsibility in its assessment of prospects for the economy and public finances.

The role of monetary policy is to ensure that demand does not get ahead of supply in a way that leads to more inflation over the medium term. As the MPC has made clear, it will make a full assessment at its next scheduled meeting of the impact on demand and inflation from the Government’s announcements, and the fall in sterling, and act accordingly. The MPC will not hesitate to change interest rates as necessary to return inflation to the 2% target sustainably in the medium term, in line with its remit.”

Subsequently, UK interest rate swaps for the week ahead fall following the BOE statement, implying a lower likelihood of an emergency rate hike.

On Wednesday (21^st September), all focus was on the Fed policy meeting and SEP (Summary of Economic Projections) or dot plots for the Fed’s thinking about rate actions in 2023. On Wednesday, as unanimously/highly expected, Fed hikes all key rates by +0.75% and projected terminal rate +4.50% (~4.4: median 4.50-4.25) at Dec’22 and +4.75% (~4.6: median 4.75-4.50) at Dec’23. Thus, as per September SEP, Fed may hike another +125 bps to reach a +4.50% terminal rate by Dec’22; i.e. Fed may hike another +75 bps in November and +50 bps in December. At the same time Fed also projected another +25 bps hike in the entire 2023. This is more hawkish than the market expected.

During his presser/Q&A, Powell eventually acknowledged fading hopes of a safe & soft landing and the high probability of a hard landing; i.e. all-out stagflation/recession for the U.S. economy in 2023 led by housing and labor market slowdown. As usual, Powell also downplayed longer-term SEP of more than 3/6/12 months. Thus the market got some hints that if inflation does not come down meaningfully, then Fed has to again go for rate hikes for a positive real rate by H1CY23, even at a slower pace.

Fed may continue to hike either at +50 or +25 bps (slower pace) to reach a positive real rate by H1CY23 at least wrt core PCE inflation, which was +4.6% in July’22. Assuming core PCE inflation around +4% and core CPI inflation +5% by H1CY23, Fed may hike to at least +5.00/5.25% by H1CY23, so that core PCE inflation goes down to +2% levels by H1CY24, ahead of Nov’24 U.S. Presidential election without causing an all-out recession.

Fed may continue to hike either at +50 or +25 bps (slower pace) to reach a positive real rate by H1CY23 at least wrt core PCE inflation, which was +4.6% in July’22. Assuming core PCE inflation around +4% and core CPI inflation +5% by H1CY23, Fed may hike to at least +5.00/5.25% by H1CY23, so that core PCE inflation goes down to +2% levels by H1CY24, ahead of Nov’24 U.S. Presidential election without causing an all-out longer-term recession.

As per Taylor’s rule, which Fed policymakers generally follow, assuming U.S. ideal real interest at 0.50%, the Fed repo/interest rate should be +5.00% against the present +3.25%. Thus Fed has to hike another +1.75% by Mar’23; i.e. +75 bps in Nov’22, +50 bps in Dec’22, and then +25 bps each in Jan-Mar’23.

In his presser Wednesday, Powell pointed out the positive real rate of interest wrt 1Y inflation expectations or core PCE inflation (rolling 3-months average), both of which are now around +4.8%; i.e. ~+5.0%. Fed will publish the next SEP on 14^th Dec’22 and if core PCE inflation continues to move around +5.0%, then Fed may project at least a 50 bps rate hike by Jan-Mar’23. Further rate actions will depend on the inflation trajectory in Q1CY23 and subsequent Mar’23 SEP. If core PCE inflation stabilizes around +5.0%, then Fed may pause further rate hikes after March-June and wait for the actual rate hike transmission effect on the overall economy (inflation, employment, and growth).

Fed may keep the real rate of interest (wrt average core PCE inflation) between 0-0.50%; i.e. if average core PCE inflation turns out to be around +5% in CY22/Q4CY22, then Fed may keep the terminal rate around 5.00-5.50% in Q1CY23 and so on.

As a central bank, Fed can control the demand side of the economy so that it can match with the currently constrained supply side and bring inflation down to some extent. Although, mostly supply issues are now causing higher inflation, amid Russia-Ukraine/NATO war/proxy war, as a central bank, Fed must act to control demand and inflation; otherwise higher inflation will affect discretionary spending and economic growth in a more durable way.

Inflation will not come down meaningfully unless the resolution of supply chain disruptions caused by lingering Russia-Ukraine/NATO/U.S. war/proxy war. As of now, there are no signs of any resolution of this geopolitical conflict. Moreover, Russia/Putin is seeing the supply chain disruptions, subsequently elevated inflation, and resultant stagflation/recession as a golden opportunity to end ‘western supremacy’.

On the other side, Biden is also not ready to make any compromise with ‘killer’ Putin for domestic political compulsion (until at least Nov’22 mid-term election). Thus Wall Street is now bracing for an all-out recession in the coming days and plunging. White House/Biden admin can now make some compromise with Russia/Putin and also Ukraine to stop this war and reverse various economic/commodity trade sanctions. Only then inflation may come down meaningfully due to lower commodity prices (food, fuel, fertilizer, and various metals).

Now from global to local, India’s headline inflation (CPI) again accelerated for the 1^st time in 4-months to +7.00% in August from +6.71% in July (y/y). India’s core inflation also surged to +5.90% in August from +5.80% in July (y/y). On a sequential (m/m) basis, India’s headline CPI was +0.52% against the July reading of +0.46%. India’s WPI/PPI was +12.41% in August against +13.93% in July (y/y). On a sequential (m/m) basis, India’s WPI decreased -0.46% in August against a -0.13% fall in July. Overall, the average headline CPI was +6.82% in 2022 (till August), while the average sequential rate was +0.60%; i.e. an annualized rate of +7.17%. The average core CPI/core inflation in 2022 is around +6.12% (till August) against the 2021 average of +5.92%. The average WPI/PPI inflation in 2022 (till August) was +14.41% against the 2021 average of +10.76%.

Although there was some moderation of inflation in May, June, and July, it again surged and core inflation is quite sticky / elevated at around 6%, while headline CPI is around +7.00%, both substantially above the RBI target of +4.00% and also around/above RBI upper tolerance level of +6.00%.

Looking ahead, India’s inflation may surge more amid elevated demand in Festival Season (September-October-November-December); a personal channel check suggests prices jumped in mid-September. Thus jumbo Fed hiking and elevated domestic inflation may force RBI to continue to follow the Fed hiking path and RBI may hike +0.50% on 30^th September (against Fed’s +0.75%); +0.50% on 7^th December (against Fed’s probable +0.75% on 2^nd November); +0.35% on 8^th February (against Fed’s probable +0.50% on 14^th December and +0.25% in Jan’23) to reach at least +6.75% terminal rate by Feb’23 (against Fed’s +4.75%).

As per Taylor’s rule, for India:

Recommended policy rate (I) = A+B+(C+D)*(E-B) =0.50+4+ (1.5+0)*(6-4) =0+4+1.5*2=0.50+4+3=7.50%

Here for RBI/India:

A=desired real interest rate=0.50; B= inflation target =4; C= permissible factor from deviation of inflation target=1.5 (6/4); D= permissible factor from deviation of output target from potential=0; E= average core CPI=6

As per Taylor’s rule, which Fed policymakers generally follow, assuming India’s ideal real interest at +0.50%, the RBI repo/policy/interest rate should be +7.50% against the present +5.40%. Thus RBI may hike to at least 6.75% by FY23, depending upon the actual trajectory of inflation, which may surge well above +7.00% in the coming days amid higher costs of transportation fuel, and food as-well-as core inflation coupled with elevated Festival demand. If core inflation stabilizes around 5.00-5.50% by H1FY23, RBI may pause rate hikes after Feb’23. In any way, the Indian banking/money market liquidity system comes into deficit after 4-years and the Indian 10Ybond yield is again approaching the 7.50-7.75% range, while USDINR may target at least 82.00 in the coming days.

On Monday, the Indian market was helped by only IT/Techs (following rebound/short covering in Nasdaq Future and higher USDINR, but lower GBPINR also dragged), while dragged by economic growth/recession sensitive sectors like realty, metals, automobiles, banks & financials, energy (lower oil), infra, and even media, FMCG and pharma sector. In terms of percentage points, Adani Ports, Tata Motors, Hindalco, Maruti, Eicher motor, Tata Steel, ONGC, ITC, JSW Steel, Axis Bank, Bajaj Auto, Bajaj Finance, and UPL dragged between 6.3-3.3%.

Looking ahead, whatever may be the narrative, technically Nifty Future now has to 17000 for any recovery; otherwise sustaining below 16925, it may further fall to 16840/740-16650/550 and further 16300/15800-15300/195 in the coming days (depending upon the trajectory of Dow Future, which has now support around 29150/29000-28800/700 and 27500/300 levels).

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