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Annual Fixed Income: 2019 Outlook
Jan 09, 2019
10 mins | Views 10
2018 had been a watershed year for global economy with likely peaking of global economic cycle amidst tightening financial conditions, jump in long suppressed market volatility and QE by major central banker’s turning to QT. Global growth is expected to slow to 3.5% in 2019 on account of growth peaking in major advanced economies, cyclical slowdown in US in its 10th year of expansion, negative effects of the US-China trade negotiations and tighter financial conditions.
Global markets will likely remain volatile as they have to contend not only with slowing economy and a less certain Central Banks support. Commodities are also likely to stay under pressure on account of slowing global economy, but crude may be nearing the end of its down-cycle. The weakness in crude shall largely act as a stimulus for global economy.
Among major economies we expect US growth to slow towards 2.3%, as it faces constraint of a prolonged economic cycle, tighter financial conditions and negative spillover of weaker global growth and trade tensions. However, lower crude price, tax refunds, healthy consumer and business confidence, and still extant fiscal stimulus (although lower than 2018) should continue to provide support to growth. US labour market remains very tight and that should keep possibility of at least one Fed rate hike alive, but much would depend on the health of financial markets and outcome of US-China trade negotiations. Slowing economy and prospects of lower Fed hike should keep a tab on US 10 year yields.
China is expected to continue decelerating, but the ongoing policy easing starts to give floor to its growth by middle of 2019. Euro area economic growth is also expected to moderate to ~1.6% in 2019. Emerging Market Vs Developed Markets growth differential and valuation may result in relative EM outperformance. US-China trade discussion, sharp deterioration in global liquidity and sharper than expected slowdown in China are key risk to EM outperformance.
In India the strong growth momentum in the beginning of 2018 moderated in 2H driven by weakness in private consumption and next exports. However, we expect moderate growth uptick towards 7.2% to 7.5% growth in FY20, in our base case assumption of stable government post elections and only a moderate global growth slowdown. Nascent investment recovery, lower crude price, possibility of a rural stimulus and election related spending would support growth while NBFC slowdown, weak global growth and impact of political uncertainty on elections are headwinds.
Given low investments in last few years, capacity utilization has risen to highest level since 2012. While public capex into infrastructure continue to drive investments, we are witnessing early signs of revival in private capex as well. If global sentiments doesn’t worsen significantly and we have a stable government post general election, then we are set for a further pick-up in investment cycle and growth in 2019.
The benign inflation that we witnessed in 2018 has been largely driven by very low food inflation, even as core inflation remained elevated. Headline inflation consistently undershot RBI and consensus forecast through the year and trended towards lower end of RBI target range story in 2018 driven by very low food inflation. Food inflation steadily surprised on the downside driven by supply shock and deft food management by government. However, we expect the sharp decline in food inflation to at least partially normalize in 2019 driven by government’s effort to force a terms of trade adjustment in rural areas and convergence in food and non-food inflation in 2019 towards ~4.5% range.
Decline in crude price shall drive improvement in India current account and assuming average crude in 60-70 range, we expect current account deficit to be at comfortable zone of 2 to 2.5% of GDP. Capital flows, however, shall remain volatile driven by volatile global markets and May General elections. Domestic politics and global markets shall keep INR volatile but somewhat lower than extreme volatility that we witnessed in 2018.
We believe that rate cuts are farther than what markets have begun to assume and will only come if local growth begin to look significantly weaker, which will only happen when global economy begins to show distinct sign of slowdown. We think that may be the story of second half, not first. The first half of the year would be dominated by the narrative surrounding the Indian general election. We would be keenly watching for any announcement on rural/farm/universal basic income package and its fiscal and inflation impact, both for the near and long term.
AAA Corp spreads have peaked for this cycle. Current RBI is predisposed towards neutralising the liquidity faster and keeping it neutral for longer. The term and liquidity premia in short end is too high and does not correspond to current macro and RBI stance. 1-3 year bonds should wind-down the extra spread in the run up to Mar/Apr as huge OMOs start to improve banking sector’s credit deposit ratio.
While the liquidity issues facing NBFCs have receded with capital markets again lending to the sector, the lending in 2019 shall remain targeted only towards certain NBFCs particularly those with good lineage, good asset quality and long seasoning. In early 2019, we shall see asset quality issues begin to emerge in some NBFCs particularly those in the housing and real estate related sectors further exacerbating the funding issues faced by Real Estate players. Real estate developers (residential) and ancillary businesses will face pressure with funding getting choked in an already tight residential market. Commercial real estate however will continue to remain reasonably robust particularly for high grade premises till as long as supply lags demand.
On the legal side, with more proceedings started under IBC coming to a conclusion in 2019, there shall be many points of law settled with clarifications emerging that will (hopefully) further strengthen the hands of the creditors and hasten the enforcement process
Overall we expect 2019 to be characterized by slower global growth but better local growth and neutral rates, amidst global and domestic political uncertainties. The key uncertainties for 2019 are elections in India and Europe, US-China trade talks, BREXIT, and OPEC response to low crude price. Overall we expect volatility to stay elevated and we would continue to be nimble footed in our portfolio actions.
Wish you all a Happy New Year 2019!
EM: Emerging Markets; DM: Developed Markets; IBC: Insolvency and Bankruptcy Code
Source: CEIC, Bloomberg, International Monetary Fund, Central Statistical Organisation
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