Nifty tumbled on negative global cues amid the concern of faster Fed t... Nifty tumbled on negative global cues amid the concern of faster Fed tightening and the Russian threat of nuclear WW III Read more

Summary

RBI may be compelled to hike @0.50% five times (in line with Fed) for a policy repo rate of +6.50% by Feb’23

India’s benchmark stock index Nifty closed around 16953.95 Monday; tumbled almost -1.27% on negative global cues amid the concern of faster Fed tightening and Chinese COVID lockdown. Wall Street was already under pressure from Thursday on the concern of faster Fed tightening and a hard landing (economic recession). On Thursday, in his IMF panel conversations, Fed Chair Powell almost confirmed a +0.50% rate hike not only in May but maybe also in all subsequent FOMC meetings; i.e. cumulative hike of another +3.00% to reach the terminal/neutral rate of +3.50% by Dec’22. Previously the market was expecting a terminal rate of +2.75/3.00% by Dec’22. Powell also indicated an economic slowdown or even an outright recession because of faster Fed hikes and QT (balance sheet reduction).

On Thursday, in the IMF panel discussion, Powell also indicated an eventual economic slowdown in the coming days, while Fed goes for faster tightening to tame surging inflation. Powell said maintaining price stability i.e. bringing back inflation towards Fed’s 2% target is the prime objective now and for that Fed is ready for action even though such action may result in an economic slowdown and even recession in the coming days.

Powell said Fed will try its best for a soft landing; i.e. bring down the inflation by measured tightening without causing an outright recession. But Powell also admitted that this is a very tough job and eventually there may be a hard landing. Powell also pointed out Fed will not count on any help from supply-side resolution; i.e. Fed will not wait for any supply-side action from the administration and any end of the Russia-Ukraine war. Powell also emphasized that Fed will hike more than the neutral rate, which the market is currently pricing.

Powell made it almost clear that as the U.S. economy is strong enough and as the labor market is too hot, Fed has no problem with faster tightening to bring down inflation. Powell knows such faster tightening would inevitably cause a slower economy and even a rise in the unemployment rate. But Fed has no problem in slowing the economy and inflation thereof.

As a recapitulation, Fed’s Bullard (an influential policymaker) recently jawboned about the necessity for +0.75% rate hikes in May and subsequent meetings, so that Fed will find itself ahead of the inflation curve. Now after Powell’s Thursday comments and the recent deluge of comments by other Fed policymakers, the market is now beginning to take Bullard’s indication of a +0.75% rate hike seriously.

Fed may be preparing the market for +0.75% rate hikes in June and July after hiking +0.50% in May. Fed may hike the rate cumulatively to +2.50% by July which is the lower band for an estimated neutral rate for many FOMC policymakers. Then Fed will watch the actual inflation data and inflation expectations, whether there are any signs of cooling. If it cools to some extent, then-Fed may go for +0.25% rate hikes in September, November, and December to reach a +3.25% neutral/terminal rate by 2022.  But if inflation does not cool sufficiently; Fed may also go for +0.50% rate hikes in September, November, and December to reach a +4.00% neutral/terminal rate by Dec’22. Thus the market is now estimating the range of the Fed’s neutral rate from +3.25% to 4.00%, which is significantly higher than the earlier estimate of +2.50% to +3.00%.

On early Asian Monday, Dow Future, as well as SGX Nifty Future, was also come under pressure as the Chinese market tumbled on the concern that the Shanghai lockdown will spread to the capital Beijing and lead to an even greater slowdown in the global economy (due to Omicron lockdowns in China, further supply chain disruptions and resultant stagflation). But overall impact was quite limited as there was also a buzz of Chinese monetary loosening (which came true later). Moreover, USDCNY soared above 6.60 on hopes of more Chinese monetary stimulus and the speculation of an imminent devaluation by the PBOC.

A devalued Chinese Yuan will be beneficial for Chinese exports, but it will also cause lower inflation in the U.S. (lower imported inflation). Also, the Biden admin maybe now thinking about dialing back Trump tariffs on Chinese goods to lower inflation back home ahead of Nov’22 mid-term election. Biden’s approval rate is now plummeting despite he is shifting all the blame for surging inflation to Putin (Russia-Ukraine war and resultant surge in commodity/oil & gas). Thus Biden admin is now trying its best to lower inflation ahead of the Nov’22 mid-term election and thus Fed has to tighten fast, whatever may be the rhetoric.

Today’s elevated inflation is a result of higher catch/pent-up demand (after huge COVID fiscal stimulus) and inadequate supply. As a central bank, Fed has tools to control demand (by tightening), but not supply. Thus Fed has to tighten in a calibrated manner so that it cools down the hotter demand without causing an outright recession. If any central bank ignores hotter inflation for a long time, it will affect discretionary (non-essential) consumer spending and eventually economic growth.

Increases in the Central Bank’s policy rate raise the interest rates that banks and other lenders charge their customers. These include the rates on business loans, consumer loans, and mortgage loans. With increases in the policy rate, interest paid on savings products will move up as well. By making borrowing more expensive and increasing the return on saving, a higher policy interest rate dampens spending, reducing overall demand in the economy. And with demand starting to run ahead of the economy’s supply capacity, a Central Bank needs to bring/slow the economy into balance and cool domestic inflation. Higher borrowing costs will also affect business profit and household spending; i.e. corporate earnings may be affected and subsequently, there will be lower wage inflation.

Now from global to local, the market is also concerned about RBI tightening as India’s inflation surged. India’s inflation (CPI) jumped +6.95% yearly (y/y) in March, the highest since Oct’20, and much above market expectations of +6.35%. On a sequential basis, the headline CPI soared +0.96% in March, the biggest rate in 5-months, amid surging food and fuel inflation. India’s core inflation also jumped to around +6.40% in March from +5.95% in February. In brief, India’s headline as-well-as core inflation jumped not only well over RBI’s target of +4.00%, but also the upper tolerance levels of +6.00% and RBI’s FY23 forecast of +5.70%.

Looking ahead, India’s headline inflation may surge more as OMCs (oil marketing companies) refrained from price hikes of transportation fuel (petrol, diesel) and LPG till March and began rising prices from April. If the sequential growth of the CPI index is also around +1%, in line with March, then the yearly reading would come around +7.35% in April. Recent Government data shows India’s WPI (equivalent to PPI) jumped +21.07% yearly (y/y) and +2.69% sequentially (m/m) in March.

Inflation is indeed surging now on the real street from essential to non-essential goods. Various big FMCG companies already said their sales are being affected by around 10% due to product price increases. Inflation is becoming a big political issue for Modi Government. RBI was already far behind the inflation curve even before the Russia-Ukraine war and subsequent supply chain disruptions. Inflation was already substantially higher than RBI’s 4% target. The Indian economy was already under stagflation even before COVID.

As per Taylor’s rule:

India’s recommended policy rate (I) = A+B+(C+D)*(E-B) =1+4+ (1.5+0)*(6-4) =1+4+1.5*2=1+4+3=8.00%

Here for RBI/India:

A=desired real interest rate=1; 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= actual average core CPI=6

As per Taylor’s rule, which Fed policymakers generally follow, assuming India’s ideal real interest at 1%, the RBI repo/policy/interest rate should be +8% against the present +4.00% to effectively bring core inflation down to the target of +4.00% on a sustainable basis. 

But considering the reality of the situation on the ground, RBI may consider -1% as desired real interest rate and hike to 5.5-6.5% by FY23, depending upon the actual trajectory of inflation, which may surge substantially above +6.00% in the coming days amid higher cost of transportation fuel and food as-well-as core inflation. Thus depending upon the actual inflation and growth trajectory, RBI may start the liftoff by hiking +0.50% in June to match Fed’s +0.50% rate hike action. Then RBI may either hike @+0.25% or +0.50% in the rest of 4-meetings (Aug/Sep/Dec’22 and Feb’23) depending upon the actual Fed rate hike action and inflation.

India is already paying around 45% of its core revenue as interest on a public debt against America’s 9%, Europe's average 4.5%, Japan’s 15%, and China’s 5.5%. Thus India can’t afford too high a bond yield and thus it has to control inflation and RBI has to be ahead of the curve by faster tightening in a balancing way; otherwise, RBI's credibility may be at stake.

India’s bond yield is now consolidating above +7.00%. The market is now anticipating an RBI rate hike by at least +0.50% in June and subsequent 3-rate hikes @+0.50% to +6.00% repo rate by Dec’22. Then depending upon the actual Indian inflation trajectory and Fed rate action, RBI may hike in Feb’23 to reach +6.50% policy rates. Higher borrowing costs are negative for equities as corporate earnings may be affected directly as well as indirectly (as discretionary consumer spending will slow under tighter financial conditions).

But any major correction may be also a wonderful opportunity in adversity to invest in well-managed blue-chip companies that have good/feasible business plans and strong balance sheets. India is now enjoying a scarcity premium among EM markets amid vibrant democracy, geopolitical and policy stability, stable macros, and currency. With the attraction of 5D (demand, demography, democracy, deregulation, and digitalization) along with the mantra of reform and performance, India is now a favorite destination of angel investors.

The market is now concerned about India’s stagflation, widening trade deficit, lingering geopolitical conflict between Russia-Ukraine/NATO, and higher oil. Thus Nifty tumbled coupled with subdued earnings and muted guidance from HDFC twins and IT big names like Infy and TCS.

On Monday, the Indian market was supported by private banks after an upbeat report card from ICICI Bank but was dragged by metals, and energy as commodities was under pressure from the concern of the Chinese slowdown. Also, the overall market was pulled by realty, media, IT/Techs, infra, pharma, FMCG, PSU Banks, automobiles, and the service sector.

On Monday, India’s Nifty was dragged by RIL (cancellation of the deal with Future group), INFY, TCS, ITC, Tata Steel (Chinese slowdown), L&T, Coal India, Bajaj Fin, Hindalco, Sun Pharma, Titan, Tata Motors (Chinese slowdown), HUL and BPCL (further delay in disinvestment). Nifty was supported by HDFC twins (value buying from around 52-weeks low levels), ICICI Bank (upbeat earnings, asset quality, and guidance), Bajaj Auto, Kotak Bank, and Bharti Airtel.

On Tuesday India’s Dalal Street recovered and made a high around 17228.80 (Nifty Future) as on late Monday, Wall Street recovered from Powell's plunge on tech boost (M&A hopes) after Twitter decided to accept Musk’s ‘best and final offer’ to buy out the company. But on Tuesday, Wall Street again tumbled on the concern of escalating geopolitical tensions between Russia and Ukraine/NATO coupled with a mixed report card. Subsequently, SGX Nifty tumbled to around 16950 at the time of the U.S. market closing late Tuesday against NSE Nifty Future closing levels around 17211 levels.

On late Monday, Russian Foreign Minister Lavrov warned about a ‘real danger of nuclear World War III’ breaking out as forty countries including NATO prepared to meet in Germany to bolster Ukraine's military. Lavrov also accused NATO of fighting a proxy war against Russia by supplying military aid to Ukraine. Kremlin has warned Western countries of the unpredictable consequences of arming Ukraine. The Russian defense ministry said its missiles have destroyed six railway facilities that were used to deliver foreign weapons to Ukrainian forces in the Donbas region.

Looking ahead, whatever may be the narrative, technically Nifty Future now has to sustain over 16800 levels for 17000/17100-127400/17500 and 18200/18320-18400/18600; otherwise sustaining below 16750, it may fall to 16300/16000-15700/15600 in the coming days. LICI mega IPO for Rs.21B will reportedly open from 4^th May, which may suck secondary market liquidity to some extent, although DIIs may support the market.