Nifty surged to a 5-month high on positive global cues and lower inflation

The market is now expecting an RBI pause in June; Nifty EPS declined to 835 so far in Q4FY23 against 850 sequentially and 809 yearly; FY23 estimate 875

India’s benchmark stock index Nifty made a 5-month high of 18458.00 Monday on positive global/U.S. cues amid a less hawkish Fed hike and fading concern of regional bank crisis. But on Friday, Dalal Street underperformed Wall Street Futures and slumped -1.02% to close the week around 18069.00 amid the sharp declines for the HDFC duo. HDFC Bank and HDFC both lost over 5% after MSCI stated it would include the merged entity of the two companies into its large-cap index with an adjustment of 0.5 instead of market expectations of 1, driving market players to estimate an outflow of $150M from the firms.

Overall, Nifty lost around -187 points and the HDFC duo contributed almost -169 points alone. Nifty Future closed around 18130 after scaling an opening session high around 18266. But on Friday night U.S. session, SGX Nifty Future (India 50), the overseas derivative/CFD of India’s benchmark index Nifty closed around 18200 in line with the rally in Dow/Wall Street Futures on mixed NFP job reports and fading regional bank concern. Also, less hawkish Fed talks (no recession), and upbeat report cards from Apple and J&J helped.

The market was pricing around no hike on 14^th June after renewed concern about FRC last week and a less hawkish Fed hike on 3^rd May. But now, after the FRC bailout by state-sponsored JPM buyout, and strong April NFP job report, Fed’s comments (Powell/Bullard), the market is again discounting some probability of another +25 bps rate hike on 14^th June, and no cuts in late 2023. Fed may go for another +25 bps hike in June for a terminal repo rate of +5.50%, while ECB may further hike by +25 bps each in June and July.

Moreover, if core inflation does not dip below +5.00% in the Eurozone by August, then ECB may have no option but to go for a further +25 bps rate hike each in September, October and December for a terminal repo/MLF rate +5.25%. If Fed goes for another hike of +25 bps in June, then India’s RBI has no option but to match the Fed’s cumulative hike of +50 bps in May and June with a hike of +25 bps in June.

The Indian market was also boosted by Indian FM Sitharaman’s upbeat comment: “Today, many of the developed economies are on the verge of facing recession--Whereas India has zero probability of going into recession. But we can't sit with complacency because we've set a goal of becoming a developed and advanced economy by 2047.”

Dalal Street was also buoyed by upbeat PMI for April

The S&P Global data shows India’s Manufacturing PMI increased to a four-month high of 57.2 in April from 56.4 sequentially, above the market consensus of 55.8, as both output and new orders grew the most in four months, amid sustaining expansions in sales. At the same time, employment increased while suppliers were reportedly able to deliver purchased materials in a timely manner, with vendor performance improving to the greatest extent in eight months, though only slightly overall. On the pricing front, input cost inflation accelerated, due to faster rises in the prices of transportation and raw materials, while output cost inflation rose to a three-month high. Finally, sentiment improved from March's eight-month low, amid demand resilience, client inquiries, orders pending approval, and marketing efforts.

The S&P Global data shows India’s service PMI increased to 62.0 in April from 57.8 sequentially, above market forecasts of 57. The latest reading pointed to the strongest expansion in the sector since June’10. Both output and new orders rose fastest since June’10, with export business gaining for the third month and advancing the most in the sequence. Also, employment grew for the 11^th consecutive period, although only marginally. On the pricing front, input cost inflation accelerated to a three-month high from a 2-1/2-year low in March due to higher costs of food, fuel, medicine, transportation, and wages. Meanwhile, output cost inflation was the highest this year. Looking ahead, business sentiment improved, driven by marketing efforts, plans to price competitively, and an increased focus on customer relations.

Finally, the S&P Global data shows India’s Composite PMI jumped to 61.6 in April from 58.4 sequentially, pointing to the highest reading since July’10 amid quicker expansions at goods producers and service providers. New orders rose the most in almost 13 years, reflecting faster increases in new business, in both the manufacturing and service sectors. Meanwhile, job creation across the private sector remained mild, with the rates of growth broadly similar at manufacturing firms and their service counterparts. On the price front, input costs advanced at the steepest pace since January, and charge inflation reached a four-month high.

The S&P Global comments about India’s PMI:

Manufacturing PMI:

“Reflecting a robust and quicker expansion in new orders, production growth took another step forward in April. Companies also benefited from relatively mild price pressures, better international sales, and improved supply-chain conditions. It seems like Indian manufacturers have abundant opportunities to keep powering ahead. Besides seeing the strongest inflow of new work in 2023 so far, capacities were expanded through job creation, input buying was lifted and pre-production inventories rose at a record rate. At the same time, stocks of finished goods need replenishing as some orders were reportedly fulfilled from warehoused goods. Manufacturers are certainly upbeat towards growth prospects, with optimism improving from March's eight-month low on the back of contracts pending approval, rising client enquiries, marketing initiatives, and evidence of demand resilience."

Service/Composite PMI:

“India's service sector posted a remarkable performance in April, with demand strength backing the strongest increases in new business and output in just under 13 years. Finance & Insurance was the brightest spot, topping the sectoral growth rankings for both measures. Having retreated in each month since the start of the current calendar year, input price inflation quickened in April. PMI survey participants indicated higher salaries and wages awarded to staff, as well as pressures from food, fuel, and transportation costs. Accommodative demand conditions facilitated the pass-through of additional expenses to clients, with prices charged for the provision of services increasing at the strongest rate in 2023 so far. One area of weakness highlighted in the latest results was the labor market. Despite the substantial pick-up in sales growth and improved business sentiment towards the outlook, the increase in employment seen in April was negligible and failed to gain meaningful traction."

Overall, the S&P Global PMI survey indicated upbeat economic activities in March-April (Q4FY23), but hotter than expected inflation and softer than expected employment scenario. In the last year, RBI hiked the repo rate by +250 bps and core CPI declined -100 bps from around +7.0% to +6.0% on average; Indian 10Y bond yield also moved up around +100 bps from around +6.0% to 7.0%. At this run rate, if RBI goes for a pause around the 6.50-6.75% repo rate, the core CPI may further fall to around +5.0% by Mar’24 and +4.0% targets by Mar’25.

If Fed continues to hike even after June’23 to +6.00% by Sep’23 (in case U.S. core inflation surges more), then RBI also has to hike (under still elevated/sticky core inflation). In that scenario, RBI may like to keep the repo rate at 7.00% to 7.50% in CY23, depending upon the Fed rate action; as USD is the reserve/global currency, every major Central Bank has to follow Fed action to maintain bond yield/currency and policy differential (whatever may be the narrative) to control imported inflation.

Thus RBI again reminded the market on the 6^th April MPC statement about the real rate of interest of +4.50% in Feb’2019 (when RBI started the pre-COVID rate cut cycle to support economic growth); in Feb’2019, RBI repo rate was +6.50%, while headline CPI was around +2.00%, but core CPI was around +5.25%. Thus the actual real rate of interest about core CPI was around +2.25% in Feb’2019 against Rajan’ (former RBI Governor) preference of around +1.50% (1.00-2.00%).

Conclusion:

India’s RBI may also hike +0.25% on 8^th June if Fed goes for another +25 bps hike on 14^th June. Unlike RBI, Fed does not attempt to surprise the market and is sharing/providing appropriate forward guidance through not only official Fed communications but also regular Fed talks. Thus by 31^st May (the Fed blackout period begins), the market as well as RBI should know with almost 100% certainty whether Fed will go for another +25 bps rate hike on 14^th June.

If Fed refrains from any rate hike on 14^th June and only goes for a +25 bps rate hike on 3^rd May, then RBI may not go for any hike on 8^th June and may continue to be on pause until core inflation does not spike abnormally. Going by the trend between RBI and Fed rate action since Jan’22, RBI may go for a +25 bps rate hike every alternate meeting if Fed goes for similar +25 bps rate hikes in every meeting (in a hypothetical scenario).

Under Governor Das and Modi admin, RBI may prefer to keep the real rate of interest around 0.50-1.50%; as India’s core CPI is now averaging around +6.00%, RBI may keep the terminal rate between 6.50%-7.50% in the coming days depending upon the actual Fed rate action and domestic core inflation trajectory. As there are a series of state elections in 2023 and also a general election by May’24, RBI may keep the terminal repo rate around 6.50-6.75% if Fed does not go beyond +5.50% and India’s core CPI stays below +6.50%.

Ahead of May’2024 general election and also various state elections, the main challenge/incumbency factor for the ruling BJP/Modi admin is sticky inflation, especially for food and duel/energy/LPG gas cylinder and unemployment/under-employment despite huge development activities/infra stimulus and anti-corruption initiatives/platform. Thus the government is also under pressure to manage price stability to promote sustainable economic growth and prosperity.

Higher inflation in India is a structural issue associated with black/unaccounted money, supply chain issues, and also higher demand for a rapidly increasing population. As a central bank, RBI may control/reduce demand by higher interest rates, so that the constrained supply can match reduced demand and control inflation to some extent. But at the same time, supply-side actions are also required by the government/fiscal authority to ensure higher/adequate supply at reasonable prices/profit margins to ensure price stability.

So far, the Nifty EPS trend in Q4FY23 is subdued around 835 (so-far) against Q3FY23 levels of 850. The FY22 Nifty EPS was around 809, while the market was expecting around 875 in FY23 (Q4FY23). The subdued Nifty earnings are due to lingering global macro-headwinds, geo-political tensions and resultant sticky elevated inflation, both locally and globally and higher borrowing costs are affecting discretionary consumer/corporate spending, affecting earnings. Wall Street is already in an earnings recession, while Dalal Street may also face the same despite upbeat commentaries from the government.

Technical View: Nifty Future (18345 CMP)

Looking ahead, whatever may be the narrative, technically SGX Nifty Future now has to sustain over 18450 for a further rally to 18550/18725*-18850/19050* in the coming days (Bullish side). On the flip side, sustaining below 18400-18375 Nifty Future may again fall to 18225-18150/18100*-17925/17775 and 17550*/17300-17000/16800* and 16650* in the coming days (bear case scenario).

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