India’s benchmark stock index closed around 17576.30 Friday; closed almost flat on mixed global cues. On Friday, Nifty outperformed during the Indian trading session on earnings optimism led by a blockbuster report card from Axis Bank (NS:). Nifty jumped almost +450 points but stumbled to close almost flat after a similar movement in Dow Future soon after the European market opens on British political and policy uncertainty.
But SGX Nifty Future jumped/closed around 17950 Monday Asian session sessions following a huge rally in Wall Street /Dow Futures on talks of Fed pivot/pauses in early 2023 and signs that the U.S. is now talking with Russia for a possible diplomatic solution to the Ukraine war. On Friday, on Wall Street, jumped, and USD slumped on hopes of a Fed pivot/pause after a WSJ report (floating balloon by well-known Fed mouthpiece/leaker).
The WSJ report said that although the +75 bps rate hike on 2nd November is now almost a certainty, the Fed may go for slower hikes to avoid over-tightening and an all-out recession (Volcker moment). Thus Fed may start debating about the need for further calibrated tightening (smaller hikes) in November and may hike +50 bps each in December instead of another jumbo +75 bps for a terminal rate of +4.50% by Dec’22 instead of +4.75%. Fed may further hike at +25/50/100 bps in February and March to reach +4.75% or +5.00% or +5.50% terminal rate by Q1CY23 (depending upon the actual trajectory of core PCE inflation) and then take a pause for at least Q2CY23 to see the real impact of erstwhile rate hikes on the overall economy (inflation, employment, and GDP growths).
On Friday, apart from the WSJ report about probable Fed pauses in early 2023, similar narratives were also shown by various Fed officials. Overall, various influential Fed/FOMC policymakers are now talking about the slowing rate of hikes in 2023 and a possible pause after March’23; i.e. Fed talks are less hawkish than expected for the last few days.
After the BOE-British government fiasco, the market was expecting some type of Fed pivot as Fed may slow down the ongoing super tightening for the sake of global financial stability and refrain from another +75 bps jumbo hike in November and December. But some influential Fed officials almost made it clear that Fed may again go for +75 bps rate hikes in December after a similar move in November contrary to earlier expectations of +50 bps. This means that if November core inflation again comes hotter than expected, then Fed may hike +75 bps in December for a terminal rate of +4.75%; then Fed may further go for another +50 bps in Feb’23 and +25 bps in March’23 for a terminal rate of +5.50% by Q1CY23.
The U.S. economy/housing market is now cooling down amid higher borrowing costs, lower demand, tepid consumer spending (discretionary), and muted CAPEX. The U.S. employment is now almost at Fed’s maximum level despite some cooling, while inflation (core CPI/PCE) is still substantially above the Fed’s price stability target of +2.00% without any meaningful sign of cooling. The U.S. labor market and inflation may begin to cool meaningfully after Q1CY23 amid higher supply (?) and lower demand. Although the U.S. economy is technically in recession after consecutive two quarters of contraction, the labor market is still robust along with consumer spending, while core inflation is at a 40-year high. Thus Fed has no problem with further jumbo rate hikes to a positive real rate, at least wrt core inflation.
As a central bank, Fed can only 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 and Chinese recurring COVID lockdowns, as a central bank, Fed must act to control demand and inflation; otherwise higher inflation will affect discretionary consumer spending and economic growth in a more durable way.
Fed goes by core PCE inflation, which was +4.9% in Aug’22 with an average rate of +5.12%. On the other side, the normal core CPI inflation average is now around +6.20% (till September). Assuming an average of core PCE and core CPI, the median core inflation average is now around +5.50%. Inflation/core inflation may be elevated in Q4CY22 for higher festival/shopping season demand (higher consumer spending for Festival/holiday season). Thus Fed may hike to at least +5.50% by Mar’23 before any pause in Q2CY23 to gauze the effect of existing higher borrowing costs on overall inflation, and employment / economic growth (both actual data and outlook).
As per Fed’s staff report in the latest FOMC minutes, the US economy is still running substantially above potential, which is creating runaway inflation. Despite the narrative of Putinflation, the US have its supply issues like logistic and production issues, which need to be resolved by the government. Also, the resolution of the Russia-Ukraine/NATO war/proxy war along with various economic/commodity sanctions on Russia and supply chain disruptions are necessary for lowering inflation. But still, there is a real lack of political will on the part of Biden & Co to make any compromise with ‘killer’ Putin. Thus Fed may have no choice but to hike rates at least till Q1CY23 to curb demand so that it matches constrained supply.
In any way, ahead of U.S. mid-term election (24th November), Fed may start debating about the need for further calibrated tightening (smaller required hikes) on 2nd November and may hike +50 bps each in December instead of another jumbo +75 bps for a terminal rate +4.50% by Dec’22 instead of +4.75%. Fed may further hike at +25/50/100 bps in February and March to reach +4.75% or +5.00% or +5.50% terminal rate by Q1CY23 (depending upon the actual trajectory of core PCE inflation) and then take a pause for at least Q2CY23 to see the real impact of rate hikes on the overall economy (inflation, employment, and GDP growths). The market is now expecting a terminal rate of around +5.00% by Feb’23 on average.
Fed is now talking about calibrated tightening, smaller hikes, and even pauses to ensure a softish landing and a Wall Street rally just ahead of the November mid-term election, in which Biden (Democrats) is set to lose trifecta for a minority government at White House. Biden may not only lose House but also Senate on economic slowdown and hotter inflation issues (at a 40-years high). In any way, no President will like to face an election (even mid-term) with a broken stock market and thus Fed has to ensure Wall Street stability in line with its financial stability mandate.
Sensing inflation will not come down meaningfully despite jumbo Fed hikes until supply side issues, especially Russia-Ukraine/NATO/US war/proxy war gets resolved; Biden admin (U.S.) is now talking with Putin admin (Russia). On Friday, defense ministers of both Super Powers talked to avert any ‘nuclear accident’ and U.S. State Secretary Blinken said: “The United States will consider all options to advance diplomacy with Russia. There is a vacancy.”
Although cornered Putin is looking for a face-saving exit from Ukraine for the last few months and eager to talk with Biden/Zelensky, U.S.-led NATO was looking for a regime change in Russia. But now (ahead of November mid-term election), realizing that Putin had also launched an economic war on the West in the disguise of a Ukraine war, the Biden admin may be softening. Lingering Russia-Ukraine-related geopolitical tensions, subsequent economic sanctions, and supply chain disruptions are causing hotter inflation, synchronized global tightening, and recession.
Now from global to local, India’s RBI is following its U.S. counterpart Fed. RBI hiked +0.50% on 30th September against Fed’s +0.75% on 21st September. This is protecting INR from an abrupt fall and boosts FPI’s confidence. INR is not a fully convertible currency. This factor along with limited CAD/BOP (deficit) after considering buoyant service export, remittances, FDIs, and negligible external loan, India has stable macro, unlike many comparable EMEs.
Angel investors are looking for political/policy/macro/currency stability and the Indian market is enjoying a scarcity premium among EMEs due to these factors. Also, the appeal of 5D (democracy, demand, demography, deregulation, and digitalization) and the mantra of reform & performance- the Indian market is now a favorite destination for FPIs.
RBI sees resilient domestic economic activity but elevated inflation till at least FY23, not only substantially above RBI’s +4.0% target but also above the upper tolerance band of +6.0%. RBI also sees sticky domestic inflation as a function of imported higher inflation and global supply chain disruptions rather than elevated domestic demand and constrained supply. RBI virtually blamed global supply chain disruptions and elevated fuel & food prices for sticky domestic inflation as a result of Russia-Ukraine geopolitical tensions and subsequent economic sanctions (on Russia). RBI is now also concerned about global financial stability after U.K. policy chaos and BOE bailout of British Pension funds amid a plunge in bond prices; i.e. surging bond yields and also USD led by Fed’s faster policy tightening.
Thus RBI will continue to tighten to keep interest rate/bond yield differential and also under control, which will also control imported inflation and manage overall price stability. RBI has to tighten in a calibrated way to bring inflation down by curtailing demand; i.e. slowing down the economy to some extent without causing an all-out recession for a safe and soft landing.
India’s headline inflation (CPI) jumped +7.41% in September (y/y) and +0.57% sequentially (m/m), while core inflation also surged +6.10% in September from +5.90% reading in August. The average CPI is now around +6.89% (y/y), sequential reading +0.60%; i.e. annualized +7.14%, while average core inflation is around +6.12% (y/y)-all are substantially above RBI target +4.00% and also above RBI’s upper tolerance levels of +6.00%.
Looking ahead, India’s inflation may surge more amid elevated demand in Festival Season: Q3FY23 (October-November-December’22)-it will also support economic growth at the same time. Thus jumbo Fed hiking, elevated domestic inflation, and robust economic growth may force RBI to continue to follow the Fed hiking path and RBI may hike +0.50% on 7th December (against Fed’s probable +0.75% on 2nd November); +0.35% on 8th February (against Fed’s probable +0.50% on 14th December and +0.25% in Jan’23) to reach at least +6.75% terminal rate by Feb’23 (against Fed’s +4.75%).
In 2023, depending upon the actual inflation trajectory for Q4CY22 (October, November, and December), Fed may further hike at least 50-100 bps in Q1CY23. Accordingly, RBI has to hike at least +75 bps by June’23 for a terminal rate of +7.50% against the Fed’s +5.50%.
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 +5.90%. 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 5.50% by H1FY23, then RBI may pause rate hikes after June’23.
In his monetary policy statement on 30th September, RBI Governor Das pointed out pre-COVID era (June 19) real repo rate was around +2.00 to 2.50% as the repo rate was +5.75% against headline CPI around +3.00%, core CPI around +4.00% and 6M inflation expectations was around +3.4 to +3.7% (for H2FY20).
Fast forward, now RBI inflation expectation for H1FY24 is around +5%. Previously, Das also indicated that RBI will go by 6M inflation expectations, actual average CPI, and also core inflation. India’s core CPI is consistently hovering around +6.00% for the last few years even before COVID and Russia-Ukraine war led to global supply chain disruptions. India has its domestic supply chain issues and also higher demand, mainly due to the rampant flow of corrupt money in the economy generated from various government projects/CAPEX/grants and also fraudulent bank lending. Thus RBI has to tighten the policy and keep the repo rate around +7.50% by June’23, so that the real rate would be around +1.50 to +2.00% wrt at least core inflation (6.50-5.50%).
On Friday, Nifty was boosted by Axis Bank, ICICI Bank (NS:), Kotak Bank, HUL, SBIN, and Titan (NS:), while dragged by RIL, BAJAJ FINANCE, ITC, L&T (NS:), HDFC Bank (NS:), Bajaj Financial Service, HDFC (NS:), and TCS (NS:). Overall, the Indian market was supported by banks & financials (upbeat Q2FY23 report card), while dragged by media, Metal, pharma, energy, infra, IT, and automobile stocks. Looking ahead, the subdued report card of RIL released Friday evening may drag Nifty, while blockbuster earnings of banks & financials led by Axis and ICICI Bank may provide support.
Looking ahead, whatever may be the narrative, technically Nifty Future now has to sustain over 18150 for a further rally towards 18250/18375-18600 (lifetime high); otherwise sustaining below 18100-18000, Nifty Future may again fall to 17800/600-500/400 and lower levels in the coming days.