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Bullish on the positive impact of unprecedented Monetary policy support on growth
Jan 22, 2021
3 mins | Views 20343
2020 turned out to be an extraordinary year, with global growth and markets first collapsing as a result of unprecedented public health policy response to an unknown virus, and then rebounding equally spectacularly, underpinned by a truly unprecedented monetary-fiscal policy support. We expect global economy to continue with its sharp V-shaped recovery in 2021, with both EMs (Emerging Markets) and DMs (Developed Markets) participating. While there is some near term downside to growth in 1Q due to raging pandemic in Europe and US, we believe this will be a short term hit, which should subside from 2Q21 onwards as vaccine becomes more widely available and peak of winter is behind. Sero-surveys suggest that a significant section of population has already been infected and the vaccine pipeline is also quite encouraging. In any case the economic impact of pandemic is on decline.
We continue to bet on the reflation trade in 2021 as well, given economic normalisation along with persistence of aggressive monetary-fiscal stimulus. Equities and Real Estate will be key beneficiary of the reflation trade. Equities should also benefit from the growth upturn. Moreover, with bond yields so low, equity risk premium is still elevated.
We expect dollar to stay weak/ weaken further. Our view stems from counter-cyclical nature of USD, which typically weakens in periods of global growth, declining US yield differential, high current account deficit in US and USD strength on PPP basis. Weaker dollar is generally favorable for global markets and economy.
We are moderately/selectively bullish on commodities given our view on growth and dollar. Also many commodities have seen inventory drawdown in 2020. But significant rebound has already happened which may limit the upside from these levels and world incremental investments in dwellings and infra are dwindling. We are more bullish on Copper/Aluminum which should benefit from the EV/Renewable energy play.
Bonds have become richly valued and given our view on growth and the rebound in inflationary expectations, we expect yields to have bottomed out and expected to inch upwards in 2021. However, given the unprecedented monetary accommodation and Central Bank commitment, we expect the upward journey to be uneven and halting.
In India we expect FY22 growth to rebound to 13% y-y (6.2% growth from FY20) from -6% y-y in FY21. This is significantly above consensus which expects a de-growth of -8.5% in FY21 followed by a shallower 9.2% rebound and thus a flat GDP growth in FY22 over FY20. The difference between us and consensus lies in our assessment of the lower impact of the COVID-19 pandemic on economy compared to consensus, and the pace of rebound. We are guided by the experience of other economies in current pandemic, and experience of Spanish flu which point to faster return of normalcy. Besides waning pandemic, we are bullish on the positive impact of unprecedented monetary policy support on growth both in terms of rate cuts and liquidity injection.
We see little durable loss due to Covid:
1) There has been no major scarring in labour markets. Savings have gone up and labour is back on sites
2) We have seen little corporate insolvencies (MSME line + IBC suspension + just 2% restructure assets + bank guidance of little increase in NPAs)
3) Our expectation of recovery in Housing market (the anchor of construction and job growth
4) We are very optimistic on the series of measures which government has been taking to boost medium term growth
5) Global monetary-fiscal policies, healthy markets, weaker dollar and our view on global growth rebound should also be tailwind for India.
The impact of pandemic in India has been relatively less damaging and is steadily declining with steady fall in new cases, new deaths and active cases to a fraction of the peak. This is despite steady opening of economy. Substantial activity normalization will likely be over before large-scale vaccination happens. Moreover, different sero-surveys indicate that a significant proportion of the population (20 – 50%) might have already been infected. However, vaccine rollout will still be important for boosting sentiments, which would be crucial for urban consumption and capex. Improving financial conditions shall also aid in growth recovery. We expect inflation to ease from current levels to average 4.5-5% in CY21 led by food inflation, even as core may turn out to be somewhat sticky. India’s external account should stay benign with another year of record surplus, although the composition of surplus would shift towards more from capital inflows and less from current account, which is likely to return to moderate deficit.
India Monetary policy and fixed income market
RBI responded very aggressively to the pandemic resulting in sharp fall in rates and significant easing of borrowing cost and financial conditions. In our view, tight monetary policy and positive real rates were a key reason for the growth slowdown and the reversal should be positive for growth. RBI’s accommodative stance is expected to continue till they are convinced of a broad-based economic recovery. However, we have reached peak of monetary accommodation and future steps will likely be on the withdrawal of this extra-ordinary accommodation. But we believe the process of withdrawal will be gradual giving markets time to prepare.
While current environment of surplus liquidity is expected to continue through 2021 helping corporate bond spreads to remain anchored at around current levels, RBI may modulate these conditions to align the extreme short end of the curve to the operative rate. RBI’s inflation framework is also up for review and will be a key factor for broad monetary policy settings incrementally. Quality issuers in AA+ / AA rated space where yields and spreads have not compressed to pre-Covid 19 levels or earlier lows, might see additional spread tightening as further economic recovery will see credit fundamentals improve going further into 2021.
In current low rate environment, we will not see any substantial capital gains for 2021, and accrual returns will take the driver’s seat for fixed income investors while tactical opportunity to capture attractive tenor spreads is likely to continue given the steepness across yield curves. Floater and Short term funds continue to be best risk adjusted places for fixed income investors to have "accrual returns "over other fixed income assets. Fixed income investors having a longer investment horizon may also consider income fund.
ABSLAMC/ the Fund is not guaranteeing/offering/communicating any indicative yield on investments. The sector(s)/stock(s)/issuer(s) mentioned in this presentation do not constitute any research report/recommendation of the same and the Fund may or may not have any future position in these sector(s)/stock(s)/issuer(s). Recipients of this material should exercise due care and read the scheme information documents (including if necessary, obtaining the advice of tax/legal/accounting/financial/other professional(s)) prior to taking of any decision, acting or omitting to act. Further, the recipient shall not copy/circulate/reproduce/quote contents of this interview, in part or in whole, or in any other manner whatsoever without prior and explicit approval of ABSLAMC.
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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