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Fixed Income Market - Investment Outlook September 2018
Sep 24, 2018
7 mins | Views 1050
Growth Indicators
GDP data surprised on the upside with GDP growth coming at a strong 8.2% (expectation at 7.6). While the growth data was boosted by a favourable base, nevertheless, we note that growth was broad-based with most sectors showing decent growth momentum. Strong growth in important sectors like manufacturing, construction, agriculture and gross fixed capital formation suggest that the growth uptick has some legs.
June IIP surpassed expectations at 5 month high of 7% y-y (Expectation of 5.5%) and May number were also revised upwards to 3.9% from 3.2%. While the number is positive and better than expectation, it has to be noted that there was a strong base of last year which is making the number look better.
August PMI data disappointed with declines in both services and manufacturing PMIs. Consequently the composite PMI declined to 51.9 from 54.1. PMI manufacturing data showed some decline in growth momentum, reflecting slower gains in output and new orders. However on the positive side, new export orders rose at the fastest pace since February. While input prices increased, the increase was lowest since April. August services PMI signalled some cooling from July’s recent-peak. However, input prices remained high in services sector as well.
Freight traffic remained healthy in railways, airport and cargo. Airport passenger traffic growth also remained strong in high-teens. Growth in steel consumption picked up further. There was some moderation in fuel consumption and auto sales, which could be due to transporter strike and rainfall season. Credit growth also continues to grow decently, but is being largely driven by services and personal loans. Bank credit to NBFC sector is growing strongly. Agricultural loans also witnessed some uptick while industrial growth stayed dismal. (Source: CEIC)
Inflation
CPI inflation at 4.17% was again a positive surprise to the market, a third such in a row. The primary attribution to this goes to food inflation, which has persistently surprised on the lower side with the last print at 1.73%. While a part of it is technical in nature due to base effect, a structural aspect to food inflation being lower persistently cannot be ignored. Steep hike in MSP can cause a disruption in this trajectory however its future evolution would be very interesting. Core inflation for second time in a row surprised on the downside after a series of upside surprises.
The fading away of HRA effects and base effects due to GST could push it further lower and hence barring some external shock we could have a benign outlook on this front. The sharp selloff in INR means that there exists a possibility of small shocks in this front. Next few reading on CPI would print around or lower than 4% on favourable base effects and hence a comfortable trajectory. However sharp rise in USDINR means that we have to remain vigilant on this front . (Source: RBI, MOSPI)
External Account
Trade deficit continued to march northwards with July trade deficit rising to the highest since May 2013 at US$18 bn from 17.1 bn in June. At current run rate of trade deficit, CAD will likely be close to the somewhat worrying level of ~3% of GDP. The uptick in trade deficit is due to higher growth in imports even as exports growth continues to show traction. Growth in imports is both in oil imports as well as non-oil, non-gold imports and a reflection of higher oil prices as well as increasing domestic demand.
INR broke to new highs amidst broad based EM selling, FII outflows, rising trade deficit and reduced intervention by RBI. Policy-makers appeared comfortable with INR weakness given the over-valuation on real effective exchange rate basis (REER), higher CAD and generalized EM weakness. We believe that at USD-INR of close to 72, INR has corrected most of its over-valuation and would be close to 10-year average on REER terms. (Source: CEIC)
Other Developments
The global composite PMI slipped further to 53.4 in August, but is still consistent with fairly healthy world GDP growth. Data for world industrial growth and trade showed some further softness, but still remain at fairly respectable levels. Global portfolio flows to EMs remained largely negative with many EM currencies witnessing sharp depreciation pressure. EM currency index declined to record lows. MSCI DM equities led by US, continued to outperform EM equities.
US economic data continues to be strong and Atlanta Fed GDP now-cast is at a healthy 4.35%. US employment and inflation data remained fairly healthy and corporate profitability and sentiments fairly strong. Markets continue to price for two additional hikes in 2018 and US government yield spread (10-2) remained fairly low at ~25bp.
China data remained mixed, with marginal rise in official PMI and decline in Caixin PMI. Chinese currency, Renminbi, declined sharply in earlier part of August but stabilized later on with PBoC indicating that it has started using counter-cyclical factor to stabilize Renminbi. Trade tension between US and China is showing no sign of abatement and President Trump is likely to announce more tariffs on China in September. Crude continued to trade within 70-80 range as markets awaits impact of Iran oil sanctions.
Portfolio Positioning
Currency weakness created sell off in rates during the month and till date. The sell-off was so major that for the moment the other fundamentals like inflations and growth have become secondary with the risk-of trajectory of USDINR becoming the dominant determinant of RBI’s policy making and thus as an extension to our portfolio actions. We have responded to this by reducing duration risks in portfolio and at the same time endeavoring to provide more liquidity to portfolios. We maintain overweight on Govt securities in our portfolios as in addition to its supply demand equation being much better, it provides much superior liquidity in face of uncertainty. As has been our theme for last few months we remain very cognizant of various uncertainties in global and local markets. Hence, we maintain a portfolio which is flexible enough to react to market developments and also actively positioned to take advantage of any opportunity across the curve.
USD: United States Dollar; RBI: Reserve Bank of India; CAD: Current Account Deficit; EM: Emerging Markets; IIP: Index of Industrial Production; PBoC: People’s bank of China; PMI: Purchasing Managers’ Index’; PSU: Public Sector Undertaking; UST: US treasury
Mutual Fund investments are subject to market risks, read all scheme related documents carefully.
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