Financial assets had a roller coaster ride as risk assets initially bore the brunt of a reversal (unwinding) of the Japanese yen carry trade in early August but closed the month on a “cheerful” note as the financial markets looked forward to an all but certain “rate cut” from the US Federal Reserve Board (Fed) in September 2024.
US employment data released in August was soft. Labour market data surprised on the downside on all major counts – July non-farm payrolls rose lower than expected; unemployment rate in July rose higher than anticipated and average hourly earnings grew less than estimated. Increased market expectations of lower interest rates in US, and the potential divergence of monetary policy action with Japan created a deadly cocktail for Japanese yen carry trade positions in early August. Global markets have since recovered from the mayhem in August and reached new highs in certain geographies as at the annual Jackson Hole Symposium, the Fed Governor Powell indicated that the time was appropriate for the policy to adjust.
The Reserve Bank of India (RBI) kept the policy rate and stance unchanged in the August meeting of the monetary policy committee (MPC). By choosing to highlight the considerable divergence between headline and core inflation, and the potential spillover risks of persistent high food inflation and unanchored inflation expectations to core inflation, the RBI has endeavoured to push back market optimisms on rate cuts and seems to be in no hurry to follow the Fed.
India’s GDP for the April 2024 – June 2024 period rose by 6.7% Y/Y (Bloomberg: 6.8%). The RBI has highlighted in the past that inflation by and large has moderated, and growth sacrifice has been minimal, but the 1QFY25 GDP print is lower than the RBI 7.1% estimate for the same period and is likely to put the RBI’s 7.2% annual GDP projection for FY25 at risk. We Expect the RBI could change the policy stance in December 2024 and reduce the policy rate in February 2025. We expect a cumulative 50-75 bps easing by the Central Bank.
Supportive global cues led bonds to close lower in August (10-year US Treasuries closed at 3.90% - lower by 13 bps [100 bps = 1.0%] over the month). India bonds too eased in the same period with the 10-year India Government Bond (GSec) ending at 6.86% - down 6 bps in August. In the near/mid term we expect the 10-year GSec to trend lower towards 6.75%. Further downside is expected to be limited till the time strong rate cut expectations from the RBI get built in – which has the potential to push down the 10-year GSec towards 6.50% or even lower if the growth inflation dynamics remains well anchored.
Increased geopolitical uncertainty, trade friction (fragmentation), policy divergence etc. are likely to be key risks for global markets over the coming years. Volatility is expected to not only continue to remain a key attribute but could also be on the rise during this period. Higher volatility led by an intermittent risk-on / risk-off environment could be the norm rather than the exception. Actively managed high-grade funds may find merit amongst investors as such funds seem well poised and nimble to be able to take advantage of opportunities in such an environment.