Should investors look for fixed income opportunities for inflation-beating returns in the current global scenario?

By Mahesh Patil

Global growth momentum continues to be subdued amid the most aggressive and synchronized global central bank tightening in 40 years, elevated geopolitical uncertainties and China’s ongoing zero-Covid policies. The global growth forecast for 2022 has been lowered to 2.9% from 4.4% at the start of 2022, with current growth now estimated at less than 2%. Importantly, the forecast for 2023 stands at 2.3%, making it the third weakest growth in the last two decades and the weakest growth outside of the global financial crisis and pandemic shock. maximum. However, despite slowing growth momentum, global CPIs, especially in advanced economies, remained at uncomfortably high levels while slowing, which has complicated policy choice in the current economic cycle.

Gradually, we believe that the political action and communication of central banks are beginning to diverge and become nuanced. As the rate hike cycle matures and country-specific factors such as the source of inflation, interest rate sensitivity and the strength of the economy diverge, recent monetary policy meetings of central banks show the beginning of a divergence between central banks. Since US inflation is largely fueled by robust demand conditions, the US Federal Reserve (Fed) has been the most hawkish of all central bankers.

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Fed Chairman Jerome Powell recently shared the three indicators of monetary tightening – the pace of rate hikes, the terminal rate, and the duration of high rates. He said that while the pace of rate hikes may slow slightly, the terminal rate will likely be higher than expected and likely to remain high for a longer period. Thus, the downturn is the “baseline scenario” for the global economy today, and the debate has shifted to how “deeper and longer” such a downturn will persist. After misjudging inflation as transitory earlier, the Fed is likely to err on the side of hawkishness until there is clear evidence of moderating inflation. The markets are currently pricing a terminal rate of 5.1% in 1H 23, which seems rather high to us. So, if the Fed delivers what markets are pricing in, we expect the slowdown in global growth to be longer.

The good news is that high-frequency indicators for India remain healthy: PMI readings are still strong, bank credit growth is the strongest in a decade, GST collections are robust, capacities are gradually increasing, supply chain pressures are easing and there are some early indications that CapEx is picking up. However, indicators such as 2W and tractor sales remain weak, reflecting an uneven recovery, with lower income groups still struggling. Despite the good economic momentum, growth is being held back by the global slowdown and the tightening of monetary policies. Thus, we expect India’s growth to approach 5%.

The Indian economy is more of a concern due to macro stability issues. India’s external account remains under pressure with an oil-driven trade deficit that remains uncomfortably high amid tighter global monetary policy. The Reserve Bank of India (RBI) foreign exchange reserves fell by US$86 billion this fiscal year and the forward book fell by a further US$60 billion. Although the revaluation contributes significantly to the decline in reserves, we must note that such a high trade deficit is unsustainable, which is the main source of pressure.

In addition to the pressure on the external account, another macro-stability variable, namely inflation, remains a concern. Even with weaker growth, Indian inflation has averaged 6.4% over the past 12 months and 6.1% since the start of the pandemic, two levels above the inflation target of the RBI. While we are likely to see a decline in headline inflation in the upcoming readings due to base effects, inflation momentum remains elevated in both core and food inflation segments. . We expect food inflation momentum to remain elevated over the coming months due to unseasonal and erratic rainfall during the monsoon season.

Ultimately, we expect the government’s efforts, which it has successfully deployed in recent years, to be critical in reducing food inflation. Our average inflation forecast for FY23 stands at 6.8%, which is slightly above the RBI forecast of 6.7%. Additionally, we need to see Indian inflation in the context of a global surge in inflation, rising global commodity prices and Covid-related shocks. In fact, it’s safe to say that our inflationary shock has been far less than what is visible in most major economies. However, what would bother the RBI is that whatever the source of inflation, if it stays elevated for a long period of time, it begins to take root, raising inflation expectations and making future attempts to reducing it more difficult and costly. .

Thus, the action of monetary policy will be guided by the double challenge of preserving both the internal (inflation) and external (exchange rate) value of the currency. While a slowdown in growth does not justify another aggressive rate hike, the aggressive cycle of rate hikes by global central bankers and the need to preserve financial stability are reasons why monetary tightening must continue. We therefore expect further rate hikes by the RBI and a terminal repo rate of 6.50%, with crude prices being the biggest headwind from a macro perspective. Liquidity has moved to a marginal deficit from a large surplus over the past six months and needs to be watched carefully as we enter the busy credit season.

There is still an “unusually” high amount of uncertainty and volatility involved, and we remain nimble in terms of positioning. We expect the 10-year G-sec to approach 7.75% in the months leading up to March 2023. demand for credit deposits, and the impact on financial stability of global factors. There is now more uncertainty than ever, which will likely put pressure on short-term rates going forward. In terms of fixed income securities, nominal rates have tightened by 275 to 300 basis points over the past six months in the short term and are now proving to be good investment prospects for fixed income investors. .

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Unlike other fixed income opportunities for short term deployment in these uncertain times, we advise investors to invest in very short term, money market, low duration, float and short term funds. , which continue to be the best risk-adjusted places for fixed income investors. For long term investors as well, absolute levels look attractive near the three to four year mark, especially for sovereign exposure. Investors can participate through one of the passive debt index fund strategies.

In conclusion, for the first time post-Covid, fixed income is emerging as a strong alternative to other asset classes on a risk-adjusted basis. Against this backdrop, investors should reassess their total asset allocation and view fixed income as a positive bias now.

(By Mahesh Patil, Chief Investment Officer, Aditya Birla Sun Life AMC. Views expressed are those of the author. Views expressed in the article are those of the author and do not reflect the official position or policy of FinancialExpress .com. Please consult your financial advisor before investing.)

Robert D. Coleman