Global Outlook
In the US, the unemployment rate reached 4.3%, the highest since 2021 and higher than the 6-month moving average (indicating a sustained uptick in unemployment) and the labour report offered more evidence that labor demand growth is weakening relative to labor supply growth. The deterioration in the labour market is evident in sluggish non-farm payrolls, unemployment claims and unemployment rate. Non-farm payroll reading of 22,000 jobs in September was significantly lower than market expectations of 75,000 jobs.

Chair Powell also highlighted his attention towards soft labour data and slowing growth in his speech where he said - "Labor supply has softened in line with demand, sharply lowering the "breakeven" rate of job creation needed to hold the unemployment rate constant. Indeed, labour force growth has slowed considerably this year with the sharp falloff in immigration, and the labour force participation rate has edged down in recent months". While inflation risks are still tilted to the upside, the FOMC is very likely to cut rates at next week's FOMC meeting by 25bps.

In the euro zone investor confidence worsened on French politics and weaker German growth. However, German industrial production improved after better factory orders, while inflation from countries was confirmed to show slowing services trends. UK monthly GDP was at a standstill, with contraction in manufacturing of chemicals and electronics offsetting decent trends in services and construction. China's slower export gains and fading fiscal support is likely to slow China's growth. Financing data continued to show weak trends. Anti-involution pushed industrial production and investment down further.

Domestic Outlook

Growth
India real GDP growth for 1QFY26 surprised on the upside at a strong 5-quarter high of 7.8% y-y even as nominal GDP growth was weakish at 8.8%. The divergence was on account of low inflation with GDP deflator at very low 0.9% y-y. Breakdown of GDP data show strong momentum in services growing at 11.3% in nominal terms and 9.3% y-y in real terms. Manufacturing growth was also strong. Although the headline GDP figure appears robust, it's likely overstating the true growth momentum. This distortion stems from a very low deflator, as India does not employ double deflation in its GDP calculations. Consequently, when inflation and commodity prices fall sharply, the headline growth number tends to spike artificially—typically followed by a correction or "payback" about four quarters later. Despite the strong GDP growth in 1Q, recent high frequency growth indicators are suggesting moderation in activity July-August. Our outlook on growth for the rest of FY26 is mixed and broadly unchanged from FY25 at close to 6.5%. While the impact of US tariffs on India is a drag, recent significant indirect tax cuts, good monsoon and while real GDP growth may remain artificially boosted in FY26 due to low GDP deflator, it can fall in the next fiscal year, if nominal GDP growth remains muted and GDP deflator picks up based on higher CPI and WPI inflation.

Fiscal Position
Ministry of Finance officials have assured that GST 2.0 will be fiscally sustainable, with higher consumption expected to offset any shortfall in revenues. The reduction in GST rates has been largely offset by moving items previously subject to compensation cess into higher tax brackets under the general GST structure. The fiscal impact of INR 48,000 crs (0.14% of GDP) divided between center and states in 2:1 ratio is quite manageable, especially given that the impact for FY26 will be only for part of the year, and there will likely be a boost in consumption immediately after the tax cut comes into effect. While overall tax collections through July have been somewhat below the seasonal trend, if we exclude income tax, collections remain broadly in line with the historical median. The shortfall in income tax collections is likely attributable to the extended filing deadline. Moreover, higher RBI dividend has also provided fiscal cushion to government as visible in significantly high non-tax revenues.

The 50% U.S. tariff on Indian exports which is an evolving situation as trade negotiations and welcome remarks have been exchanged over between the President of United States and our Prime Minister. Tarrif's are a concern due to its potential impact on both growth and the balance of payments. However, the implications for the fixed income market are mixed. While currency pressure is a negative for fixed income, the resulting drag on growth could prompt a monetary policy response. The government has not indicated any major fiscal support, and we do not expect fiscal risks to become significant. That said, we will closely monitor tariff-related developments, which we view as a key risk to our constructive outlook.

Inflation
India headline inflation for August 25 came in at 2.1% y-y in line with expectations (sequential inflation was at 0.5% m-m v/s 1.0% m-m last month). Core CPI came in flat at 4.1% y-y v/s last month (was higher by 0.4% m-m driven largely by gold / silver prices). Super core inflation (ex-gold and silver) came in lower at 3.1% y-y v/s 3.2% y-y last month.

Food price inflation continued its disinflation trajectory on back of base effects showed a 0.7% y-y decline, whereas the sequential increase was more muted than what we saw last month. Meat, Fish and Egg prices have shown major sequential decline which is generally seasonal.

Heavy rainfall in the north-western states can cause some strain to food inflation on the higher side. The government has already started supply side measures to counter the same. However, we see a higher offsetting impact on back of GST rate cuts.

With next food output also expected to be good, recent significant indirect tax cuts announced by government and low global commodity prices, we expect inflation to continue to stay benign. September inflation basis current high frequency data in our estimates is expected at ~2% y-y and October headline inflation is expected to come around 1% y-y. We see FY26 average inflation at less than 3% which will open space for further monetary easing by RBI.

Investment Recommendations
In the current environment it will be favorable for investors to increase allocation and duration in their fixed income portfolio keeping in mind their risk-appetite and investment horizon and accordingly recommend the following:

1. ABSL Government Securities Fund and ABSL Long Duration Fund: For investors keen to run higher duration risk and take benefit of the current demand / supply dislocation with a 6 months + investment horizon

2. ABSL Corporate Bond Fund and ABSL Banking PSU Debt Fund: For investors keen to take benefit of currently high spreads and should look to invest in short term fund category given the healthy absolute level of rates in relatively moderate duration. Our ABSL Corporate Bond fund and ABSL Banking PSU fund are best placed for this strategy

3. Liquid play: Our 3-6 month index fund and ABSL Low Duration Fund is good avenue for liquidity / cash management by investors.

Sources: ABSLAMC Research, Federal Reserve, RBI, CSO, MOSPI
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The views and opinions expressed here are personal and do not necessarily reflect the views of
Aditya Birla Sun Life AMC Ltd ("ABSLAMC")/Aditya Birla Sun Life Mutual Fund ("the Fund").

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