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Investment Insights

Suyash Choudhary

We had observed in February as to how global policy seemed to be shifting, responding to the synchronized slowdown narrative on global growth (https://www.idfcmf.com/insights/policy-puts-start-re-emerging/). With the European Central Bank (ECB) and US Federal Reserve (Fed) policy meetings since then, these initial ‘put’ options have now been significantly strengthened. Both these central banks ended up sounding much more emphatically dovish than was expected. The ECB downgraded growth and inflation forecasts, committed to keeping interest rates unchanged at least through the end of 2019, and launched a new series of quarterly targeted longer-term refinancing operations (TLTRO-III), starting in September 2019 and ending in March 2021, each with a maturity of two years.

 

The template was similar for the Fed where growth, employment and inflation projections were also downgraded. The collective assessment of members suggests no further rate hikes in the current year and just one more in 2020. To put this in perspective, the collective forecast as recently as in December was for two additional hikes in 2019, and one more in 2020. Further the Fed will start slowing the pace of balance sheet run offs from May and cease reductions in balance sheet altogether at the end of September 2019. With this the Fed has managed to throw a dovish surprise to markets in its second successive meeting. There is a view that perhaps it has been a shade too quick in locking itself into this new dovish stance, especially as the outlook on the economy still remains relatively robust and the theme rather is that an above trend growth is converging towards trend.

 

Our best guess is that this turn in the Fed is rooted in evolving inflation expectations. A hint towards this was given by the Fed Chair in his post policy conference where he seemed to suggest that even after almost 10 years of economic recovery inflation expectations have remained relatively muted. We include below a quote by Chair Powell from the most recent post policy press conference:

 

“It’s one of the major challenges of our time, really, to have inflation, you know, downward pressure on inflation let’s say. It gives central banks less room to, you know, to respond to downturns, right. So, if inflation expectations are below two percent, they’re always going to be pulling inflation down, and we’re going to be paddling upstream and trying to, you know, keep inflation at two percent, which gives us some room to cut, you know, when it’s time to cut rates when the economy weakens. And, you know, that’s something that central banks face all over the world, and we certainly face that problem too. It’s one of the, one of the things we’re looking into is part of our strategic monetary policy review this year. The proximity to the zero lower bound calls for more creative thinking about ways we can, you know, uphold the credibility of our inflation target, and you know, we’re open-minded about ways we can do that.”
 
(Source: https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20190320.pdf)

 

U.S. consumers’ inflation expectations

 

graph1_2617

 

The graph above charts various measures of consumer inflation expectations over longer periods of time. What is noteworthy is the recent dip in expectations despite the US economy having grown substantially above trend only last year. This, then, seems to us as the most telling reason behind the Fed’s remarkable policy U turn. More generally, and as also gleaned from the comments above, developed market (DM) central banks are only too aware that their policy toolkits are asymmetric: there is much more scope to address an upturn in inflation / growth versus a downturn.

 

U.S. yield curve
 

graph1_2617

 

The second graph charts the evolution of the US yield curve over the past year. As can be seen, there has been a remarkable flattening of the curve with parts of the curve now being inverted for the past few months. While the significance of curve inversions continues to get debated, it is definitely a market signal that the Fed may have found difficult to ignore as well.

 

Finally, recognition of a synchronized slowdown may very well herald a renewed phase of competitive currency depreciation. It is to be noted that this is never explicitly acknowledged by most central banks. Rather, a relatively strengthening currency feeds into policy decision making via a relative tightening of financial conditions. So far with the Fed actually hiking into a strengthening economy, a strengthening US dollar was an outcome it may have been happy to accept. Indeed, the whole point of hiking rates and running off the balance sheet would have been to net tighten financial conditions. However, this may no longer be the case going forward. Thus the Fed turn may also partly be owing to a desire to not allow financial conditions to net tighten going forward.

 

Implications

 

Major DM central banks turning dovish has green-lighted renewed robust investor allocations to emerging markets (EMs). This also provides EM central banks room to turn more accommodative without worrying about currency pressures. This being the backdrop, India itself has a soft growth – inflation set up for now and a new governor who seems to have a much stronger reaction function. This makes for a continued bullish signal for quality bonds.

 

MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency about the investment strategy / theme of the Scheme and should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. The information/ views / opinions provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision and the security may or may not continue to form part of the scheme’s portfolio in future.  Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. The decision of the Investment Manager may not always be profitable; as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. Neither IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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Suyash Choudhary

RBI Expands Liquidity Tools

By: Punam Sharma

The RBI has announced a new tool for liquidity creation and decided to inject rupee liquidity for 3 years through long-term foreign exchange Buy/Sell swap. Under this, the RBI will buy up to USD 5 billion from the market via auction on 26th March, and simultaneous sell it back to the same counterparties effective March 2022. Whatever amount of dollars get mopped up via these operations will reflect in RBI’s foreign exchange reserves for the tenor of the swap while also reflecting in RBI’s forward liabilities. Meanwhile, the system gets rupee equivalent liquidity for the same amount and for the same duration.

 

Given the novelty of the tool and the unexpected announcement, market interpretation of this is still fluid. The first movers are a fall in USD/INR forward premium as well as a reasonable rally in front end corporate bonds. A lower hedge cost should incrementally incentivize off shore flow into Indian ‘carry’ assets (corporate bonds chiefly). The imponderable still is whether the system will be able to tender the whole USD 5 billion in the current auction. An underlying context, however, is the recent revival in dollar flows from portfolio investors also augmented by hopes of one time purchases under the domestic stressed asset resolution process. Also, once the tool is introduced, it is quite likely that the RBI follows this up with further such auctions. If so, then cost of hedge may remain better anchored for the longer term thus making rupee assets that much more attractive. A first reaction of the move also is that the new tool implies that many fewer OMOs. This means that the steepening tendency of the yield curve that has been in play for most of this calendar year persists for now.

 

From a more medium term perspective, this may also imply that the RBI is stepping up efforts for transmission. This move, although unconnected, comes close on the heels of the country’s largest public sector bank linking its rates on savings deposits as well as on cash credit lines to the repo rate. That move has also been hailed as a significant step in the direction of ensuring better transmission of monetary policy. If RBI has indeed stepped up efforts in this direction, it is very consistent with our expectations from the new Governor. We had outlined in a recent note our assessment that monetary policy has turned more emphatic under Mr. Das and that it was possible to envisage the central bank turning even more proactive on liquidity. We had also concluded that this seemed the right approach for now given the global backdrop and the muted local growth-inflation mix (https://www.idfcmf.com/insights/policy-puts-start-re-emerging/).

 

We have been continuously flagging that 2 – 5 year AAA corporate bonds offer the best risk-reward on the yield curve.  This move further enhances their appeal on the margin. Investors should ensure that they don’t get so side-tracked by the worries in the credit market that they miss out on the clear opportunities in the quality part of the fixed income market.

 

Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency about the investment strategy / theme of the Scheme and should not be treated as endorsement of the views / opinions or as an investment advice. This document should not be construed as a research report or a recommendation to buy or sell any security. This document has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. The information/ views / opinions provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The recipient should note and understand that the information provided above may not contain all the material aspects relevant for making an investment decision and the security may or may not continue to form part of the scheme’s portfolio in future.  Investors are advised to consult their own investment advisor before making any investment decision in light of their risk appetite, investment goals and horizon. The decision of the Investment Manager may not always be profitable; as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. Neither IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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