Do it yourself: Fed

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Tuesday, July 1, 2025

Investors’ dilemma – Consolidation vs Capex vs Consumption

After several years of corporate & bank balance sheet repair and fiscal correction, the contours of India's next economic growth cycle are beginning to emerge. With the Reserve Bank of India (RBI) maintaining a growth-supportive stance; union government showing strong commitment to fiscal consolidation, easing financing pressures for the private sector; and global markets showing signs of stabilization as geopolitical confrontations ease and trade disputes settled; the stage is set for a potential economic upswing.

The spotlight is now on three competing themes — corporate consolidation, private capex, and household consumption — each pulling investor attention in different directions.

Corporate begin to re-leverage

After many years of deleveraging, corporate debt in India appears to have bottomed out and is now beginning to rise. This shift in trajectory marks a significant departure from the post-2016 era, where Indian companies focused on strengthening balance sheets following a wave of over-leveraged investments. According to recent analyses, corporate borrowing is rising as businesses seek to capitalize on emerging opportunities.

This shift is supported by a monetary environment that remains broadly pro-growth. The Reserve Bank of India (RBI) has maintained a balancing act between containing inflation and supporting economic momentum. Rates have been cut aggressively and RBI is pushing for a quick transmission.

Fiscal consolidation by the union government is also helping to ease crowding-out pressures in the credit markets. With the Centre projecting a glide path toward more sustainable fiscal deficits, room is being created for the private sector to tap into financial resources more freely.

RBI’s Growth-Supportive Stance and Fiscal Consolidation

The Reserve Bank of India has definitely turned growth supportive in the past one year, after maintaining a delicate balance between inflation growth. The rates have been cut aggressively and liquidity conditions have been made favorable. Targeted interventions to support small and medium enterprises (SMEs) and infrastructure projects, have bolstered private sector confidence.

Simultaneously, the Indian government’s commitment to fiscal consolidation has eased pressure on private financing. By reducing the fiscal deficit—projected to decline to 4.4% of GDP in FY26 from 5.6% in FY24—the government is crowding in private investment. Lower government borrowing means more capital is available for private enterprises, reducing competition for funds and potentially lowering borrowing costs. This synergy between monetary and fiscal policy is creating a fertile ground for private capex to flourish.

Global context changing quickly

Globally, financial markets have been navigating turbulent waters for the past some time. Monetary policies remained tight in major economies like the United States and the European Union. Geopolitical concerns were elevated as multiple war fronts were opened. The political regime changes in the US early this year, also triggered an intense trade war.

However, recent developments suggest a quick shift. There are conspicuous signs of geopolitical stability, particularly with noteworthy steps toward peace in conflict zones. The US administration is showing significant flexibility in negotiating trade deals, raising hopes for an early and durable end to tariff related conflicts. Inflationary pressures are also easing, especially with stable energy prices. These all factors combined raise hopes for a global monetary easing cycle. The US Federal Reserve and the European Central Bank have hinted at potential rate cuts in 2025, which could lower global borrowing costs and improve capital flows to emerging markets like India.

For India, this presents an opportunity to attract foreign portfolio investments (FPIs) to boost market sentiments, as well as foreign direct investment (FDI) for long-term projects, especially in manufacturing and green energy. The government’s Production-Linked Incentive (PLI) schemes and “Make in India” initiatives are well-positioned to capitalize on this opportunity, but execution will be key.

Investors’ dilemma

Amidst corporate optimism, supportive policy environment, positively turning global context, investors and traders are facing a dilemma – whether to stay bullish on the capex theme or turn focus towards the consumption theme that has been lagging behind for the past couple of years.

In my view, investors need to examine two things—

1. What is driving this resurgence in corporate debt?” Is it being used to fund acquisitions of operating or stressed assets, or is it fueling fresh capacity creation?”

2. Whether easing inflation, lower interest rates, good monsoon, and improved employment prospects due to capex translating to on-ground activity, will accelerate private consumption growth, or households will focus on repairing their balance sheets and increase savings?

What is driving this resurgence in corporate debt – Consolidation or capacity addition?

The distinction is crucial. While the former drives job creation, productivity, and long-term growth, the latter may only temporarily improve capital utilization rates and return metrics. Acquiring distressed assets or merging with competitors may lead to short-term efficiency gains but could delay the broader economic benefits of new capacity creation. Whereas, investments in fresh capacities could signal a long-term commitment to growth, aligning with India’s aspirations to become a global manufacturing hub.

While mergers and acquisitions (M&A) activity has been robust in the past few years, particularly in sectors like infrastructure and manufacturing, greenfield investments have seen limited areas like renewable energy (driven mostly by government incentives) and steel.

Equity markets are evidently betting on a capital investment Supercycle. Stocks of capital goods makers, construction contractors, and building material firms have seen sharp re-rating over the past year. Order books are swelling, and forward guidance from several listed players suggests growing optimism.

Consumption paradox

While the equity markets are bullish on capex-driven sectors, investor enthusiasm for household consumption remains subdued. This is puzzling, given the macroeconomic tailwinds that should theoretically support private consumption. Easing inflation, which dropped to 4.7% in mid-2025, coupled with the prospect of lower interest rates and improving employment prospects due to rising capex, should create a virtuous cycle of demand. Yet, private consumption, which accounts for nearly 60% of India’s GDP, has been lackluster over the past two years.

Several factors may explain this paradox. First, uneven income distribution means that the benefits of economic growth are not reaching all segments of the population equally. Rural consumption, in particular, has been hampered by volatile agricultural incomes and inadequate infrastructure. Second, high inflation in essential goods like food and fuel, despite overall moderation, continues to erode purchasing power for lower- and middle-income households. Third, policy support in the form of subsidies and cash transfers is being gradually unwound as fiscal discipline returns. Finally, the stress in the household balance sheet, especially in the wake of the Covid-19 pandemic may have also hampered consumption growth.

The equity market’s lack of enthusiasm for consumption-driven sectors like FMCG (fast-moving consumer goods) and retail reflects these concerns. Investors appear to be betting on a capex-led recovery rather than a consumption-driven one, prioritizing sectors poised to benefit from infrastructure spending and industrial growth. However, sustained economic growth will require a revival in household consumption, as capex alone cannot drive inclusive prosperity.

What to do?

The question is what investors should do under the present circumstances? Should they continue to back the obvious beneficiaries of capex — engineering firms, infra developers, lenders to industry? Or should they begin building positions in consumption plays, in anticipation of a cyclical rebound?

In my view, both themes may ultimately play out — but on different timelines. Capex is here and now, led by policy push and balance sheet strength. Consumption is the laggard, but if the macro indicators hold, its turn could come with a lag of a few quarters.

Thursday, April 17, 2025

Looking beyond Mr. Bond

Continuing from yesterday…Mr. Bond no longer a superstar

Given my view that the yield curve is no longer a strong leading indicator, I prefer to use a mix of indicators to assess the likely direction of the markets. Mortgage rates, credit growth, credit terms, repo outstandings and the size of the central bank’s balance sheet are the most prominent ingredients in the mix I like to use.

For example, in the context of the US, Mortgage rates are a close pulse on borrowing costs, consumer behavior, and economic health, less abstracted than the yield curve. In the U.S., the 30-year fixed mortgage rate tracks loosely with the 10-year Treasury yield—historically about 1.5 to 2 percentage points higher—but it’s more than just a derivative. It folds in lender risk appetite, housing market dynamics, and Fed policy fallout in a way that hits Main Street directly.

Presently, mortgage rates are climbing—30-year fixed is around 6.8%, up from 6.4% in late March, shadowing that recent 10-year yield jump to 4.5%. That’s despite recession odds rising, which, one may assume, would pull rates down as safety bets pile into bonds. Instead, it’s signaling stubborn inflation expectations (CPI still above 3%) and maybe some lender jitters about defaults if the economy wobbles. Post-2008, mortgage rates have also been a better tell on how QE and rate hikes filter through—when the Fed bought $2.5 trillion in mortgage-backed securities, rates stayed low even as Treasuries twitched. The curve didn’t catch that nuance.

Mortgage trends usually sidestep central bank distortion. The Fed can pivot Treasury yields, but mortgage rates reflect a messier mix—banks’ funding costs, housing supply, wage growth. In 2022, the curve inverted, but mortgage rates soared from 3% to 7% clearly indicating “tightening ahead”.

Mortgage rates provide a frontline view of credit conditions and consumer stress—80% of U.S. household debt is tied to mortgages—without the Fed’s thumb on the scale.

Credit growth, credit terms and repo outstandings pair well with mortgage rates to assess the genuineness of demand supply equilibrium of the credit market. Together, they cut through the noise of central bank meddling and give a clearer view of whether demand and supply are truly balancing or just riding artificial waves.

Credit growth is the engine’s RPM. It tells you how much new borrowing—household, corporate, or government—is fueling the system. In the U.S., total credit to the private sector grew at a sluggish 2.5% annualized rate in Q1 2025, down from 4% in 2023, as per Fed data. That’s tepid, especially with mortgage rates at 6.8% crimping home loans—mortgage debt growth is barely 1% year-over-year. Meanwhile, consumer credit (credit cards, auto loans) is up 5%, hinting that people are leaning on short-term debt as housing gets pricier. If credit growth stalls while mortgage rates rise, it’s a sign demand’s weakening—banks aren’t lending, or borrowers aren’t biting.

Credit terms are the fine print—how tight or loose lenders are with the purse strings. Are banks demanding higher credit scores, bigger down payments, or jacking up spreads on corporate loans? Right now, the Fed’s Senior Loan Officer Survey (Q4 2024) shows tightening standards on commercial loans—net 15% of banks raised hurdles—while mortgage terms eased slightly, with down payment requirements dipping to 10% on average from 12% in 2023. High-yield bond spreads are at 350 basis points over Treasuries, up from 300 in January, signaling risk aversion. If terms toughen as mortgage rates climb, it’s a red flag—supply’s there, but lenders don’t trust demand to hold up.

Repo outstandings are the plumbing’s pressure gauge. The repurchase market shows how much short-term cash banks and funds need, and how willing they are to leverage. As of April 2025, U.S. repo volumes are hovering at $2.8 trillion daily, per NY Fed data, up 10% from last year. In a “genuine” equilibrium, repo would hum along smoothly, not swell like this while credit growth lags.

Mortgage rates at 6.8% look less alarming if credit’s flowing, terms are loose, and repo’s calm—demand and supply are moving in tandem. But slow credit growth, tightening terms, and repo pressure say the market’s strained—supply’s there, but demand’s shaky, and liquidity is a crutch. Central banks can twist yields all they want; these metrics show what’s really moving.

Central bank’s (CB) balance sheet is another key watchable for me. If CB takes too much paper on its own balance sheet, it indicates an attempt to unfairly influence the bond market equilibrium.

CB’s balance sheet is a massive lever they can pull to sway markets, and when it swells too much, it’s a flashing sign they’re trying to muscle the bond market into line rather than letting it find its own footing. As of April 9, 2025, the Fed’s balance sheet sits at about $7 trillion, down from its $8.9 trillion peak in mid-2022 but still a hefty chunk—roughly 25% of U.S. GDP.

Fed loading up on paper—mostly Treasuries ($4.3 trillion) and mortgage-backed securities ($2.3 trillion) as of late 2024—is a deliberate play to augment liquidity or cap yields.

In a free market, bond yields would reflect investor sentiment—fear of inflation, growth bets, default risks. But when the Fed gobbles up $95 billion a month or steps in with “emergency QE” like some predict if Treasury markets seize up again, it definitely distorts the equilibrium.

I use the classical 2:1 debt equity parameter used to benchmark the corporate balance sheets, to assess the central bank’s balance sheet also. I think M2 (Money Supply or Central Bank’s liabilities) should not be more than 2x of the assets on its balance sheet.

For context, in the US M2 money supply is close to US$21 trillion, versus the Fed’s assets of US$7trillion. That is a 3:1 debt equity ratio for the Fed. This implies excess liquidity from years of bond-buying ($4.3 trillion Treasuries, $2.3 trillion MBS on the Fed’s books). Pre-GFC M2 to Fed balance sheet ratio reached 8:1. Banks were churning out loans—subprime mortgages, leveraged buyouts, etc. —while the Fed’s balance sheet stayed lean, mostly short-term Treasuries. Reserves were minimal ($10 billion or so), and the fractional reserve system let M2 balloon. When the housing bubble popped, that 8:1 leverage meant there was no cushion—credit froze, banks choked, and the GFC happened.

Wednesday, April 16, 2025

Mr. Bond no longer a superstar

The conventional market wisdom suggests that the bonds usually lead the change in market cycles. Traditionally traders have closely followed the yield curve shape, benchmark (10 year) yields and high yield credit spreads to speculate the near term moves in equity, currency and commodity markets. Two simple reasons for this traditional practice are –

(i) Bond markets are usually more correlated with the economy.

(ii) Size of bond markets is materially larger than the equity, currency and commodity markets. It has the largest number of leveraged positions at any given point in time; and most of the large and influential market participants are more active in bond markets as compared to the other markets.

I am however inclined to disregard this piece of conventional wisdom. In my view, it would make sense only if the markets are operating in a free and fair manner. In cases where the central bankers and governments (through Sovereign Wealth Funds and other institutions controlled by it) actively and frequently intervene in the market, effectiveness of bond markets in leading the markets is impaired.

The world has definitely changed after the global financial crisis (GFC 2008-09). Central bankers, government, and public institutions are now playing significantly more active roles in the financial and commodity (especially gold and energy) markets. Bond prices are often influenced to suit the objectives of fiscal policy. Stock prices are influenced to suit political expediency.

Even pre-GFC, equity and bond traders did look at proxies like USD/CHF or copper—known as "Dr. Copper" for its economic sensitivity—for directional cues. In the past one decade we have seen Japan’s central bank buying equities; India’s government nudging markets via state-owned entities like LIC; the US Fed’s quantitative easing indirectly supporting massive amounts of stock buybacks; and Sovereign wealth funds in the Gulf Cooperation Council (GCC) countries piling into equities. This clearly indicates that in markets "no fixed formula works forever." Markets are adaptive. What held true for the past 35 years might not hold for the next 35.

US Bond yields no longer a lead indicator

In my view, the yield curve is fully relevant only if the market is free and genuine demand supply equilibrium of bond prices is discovered by the market forces. In situations where central bankers direct, manipulate or regulate yields, the yield curve is materially less important.

There is plenty of recent evidence, pointing that the US bond yields are no longer a strong indicator of the economy and/or markets. For example, consider the case of the US yield curve inversion in 2022-23.

Typically, an inverted yield curve—where short-term Treasury yields exceed long-term ones—has been a reliable harbinger of recession, preceding every U.S. downturn since the 1950s with a lag of roughly 6 to 18 months. The inversion that began in July 2022, peaking in mid-2023 with the 10-year/2-year spread hitting around -100 basis points, was the longest on record, lasting over two years. By historical standards, a recession should’ve hit by mid-to-late 2024. However, it has not happened; and the GDP growth held steady at 2.8% annualized in Q4 2024, and unemployment remains low at 4.1% as of March 2025.

Moreover, after un-inverting in September 2024—when the 2-year yield (around 3.6%) briefly dipped below the 10-year (around 3.8%)—yields have climbed across the board in the last two weeks. This morning, the 10-year yield is hovering near 4.5%, up from 4.0% in late March, while the 2-year has risen from 4.1% to about 4.5%. Incidentally, this rise coincides with a spike in recession odds, with the New York Fed’s yield curve model pegging the probability of a recession by mid-2026 at around 40%, up sharply from 25% a month ago. Normally, you’d expect yields to fall as recession fears mount, reflecting a flight to safety and anticipation of Fed rate cuts.

Prima facie, it appears that the bond market is more concerned about the rising inflationary expectations, particularly in light of the latest tariff policy of the US government. CPI is currently running above 3%—and there is skepticism about the Fed’s willingness to cut rates meaningfully from their current 4.75%-5.0% range. Higher yields also reflect a demand for more compensation amid uncertainty which could stoke inflation further. Arguably, the economy’s resilience—strong consumer spending, a robust labor market—may have also impaired the yield curve’s predictive edge this time. Structural shifts, like massive Fed balance sheet expansion since 2008 or global demand for long-term Treasuries, have certainly distorted its signal.

The recent yield rise despite recession odds implies that bond traders are betting on tighter policy or inflation risks, despite economic data flashing slowdown warnings (e.g., manufacturing PMI below 50 for months).

Conclusion: The yield curve’s relevance erodes when it’s less about market discovery and more about central bank glide path. Though it’s still worth watching, it’s no longer the king it once was in a freer market.

Tomorrow I will share my thoughts of what could be a better indicator, or aa mix of indicators to assess the likely market direction.

Wednesday, March 26, 2025

Loving silver on my scalp

A friend recently remarked, “I don’t want to be young for the first time in my life”. He was alluding to the challenges Gen Z (born between 1997-2012) and Generation Alpha (born after 2012) children are likely to face in the coming years. I fully agree with him. The silver on my scalp gives me comfort that a relatively well lived life may end as comfortably for me, and many people my age. But young people in their 20s have no such comfort.

The people in their late twenties have already stood witness to three massive economic/market crises (dotcom burst, subprime burst and Covid-19 pandemic) that (i) were not caused by a war or natural disaster; (ii) did not cause human suffering which was anywhere closer to the crises witnessed during 19^th and 20^th centuries; and (iii) were brought under control through monetary and fiscal stimuli within a short period of time.

In the past twenty-five years, the governments across the world have increasingly become more socialist. While serving the interests of crony capitalists, they have made sure to provide basic necessities of life to the common people – not only in their jurisdiction but much beyond it. The central bankers across the world have remained accommodative – keeping the markets sufficiently liquid, and cost of capital low to fuel consumption, support higher asset prices and ensure availability of adequate risk capital to fund tech innovation.

This generation has mostly lived in low inflation, low interest rates, constantly improving productivity due to tech innovation, accelerating speed of everything, improving longevity, globalized economies, contained geopolitical conflicts, and an environment promoting individualism against the spirit of society. Accordingly, this generation carries a strong faith in the central bankers, governments, technology, medicine, and mobility. Personal savings, family, austerity, tolerance, sacrifice, social ethos, patriotism are only a few of the concepts this generation may not be sufficiently versed with.

A famous Chinese curse goes, “May you find what you wish for”. The Gen Alpha, perhaps is affected by this curse. Riding the broomstick of unhindered aspirations, they feel entitled to get freedom, liberty, comfort and convenience, despite being mostly selfish in their approach towards society in general. They take peace and society support for granted. The very freedoms and comforts this generation seek might become their undoing, as they may not be adequately prepared for tougher times.

The events of the past few years are suggesting that things may change rather dramatically for this generation in the coming decade.

· The governments are increasingly acquiring parochial character. The focus is evidently shifting to retraining fiscal profligacies. Frugal governments mean the younger people might have toll hard to make a living for themselves. This will happen when the technological developments would have eliminated most of the jobs requiring unskilled or semi-skilled workers.

· The central bankers, as evident from the recent Fed commentary, have developed the fear of the endgame of this unmindful monetary expansion. Cheap and abundant money may not be available to fund redundant fancy tech innovations.

· The efforts of the government to define the narrower contours of personal freedom and liberties are also conspicuous from the US to India. Conforming to social norms may become essential for survival, if this continues like this.

· Excessive use of chemicals and changes in lifestyles have severely affected the procreation capabilities of both men and women, adversely affecting the demographics. “Not having family” may soon become a disease rather than an option.

· Climate change may make food and water scarce for more than half of the world.

· Ultra nationalism may trigger a war, for which not many youths would be prepared. This could lead to several times more lethal digital, chemical and even nuclear attacks. The misery that would follow is unfathomable. Of course it is the worst-case possibility, not a baseline assumption.

I am certainly not suggesting an end of the road for Gen Alpha. I am just expressing my sadness for the fact that my children may have to learn a few life lessons rather painfully.

I am confident about the capability of the young generation to quickly adapt to the changing environment. Gen Z and Alpha have grown up with smartphones, not stability—they’re naturally used to disruption. They might lack the thrift or stoicism of boomers, but they’ve got agility and a native grasp of systems (tech, social, political) that could see them through. I am sure the pain would forge something new, not just break them.

I would be keenly watching the developments in the areas of food and water; particularly, how the food production shifts from the farms to factories.

Tuesday, March 4, 2025

Lock your car

It was summer of 2013. The mood on the street was gloomy. The stock markets had not given any return for almost three years. USDINR had crashed 28% (from 53 to 68) in a matter of four months. GDP was on course to drop to 5.5% after growing at a rate of over 8% CAGR for almost a decade. Current account deficit had worsened to more than 6% of nominal GDP (the worst in decades). The Fx reserves of the country were down to US$277bn, sufficient to meet just 5 months of net imports. The confidence in the incumbent government had completely depleted. The people were on the street protesting against ‘corruption’ and ‘policy paralysis’.

The global economy had still not recovered from the shock of the global financial crisis (GFC). The thought of unwinding of monetary and fiscal stimulus provided in the wake of being unwound was unnerving most emerging markets ((Taper Tantrums), including India.

India, which was touted as TINA (There is no alternative) by the global investors just five years back and had become a key member of BRIC and G-20; was already downgraded to “fragile five” by some global analysts. This was the time when the government of the day took some brave decisions. One of these decisions was to appoint Mr. Raghuram Rajan, former Chief Economist and Director of Research at the IMF and then Chief Economic Advisor to the Government of India, as the 23^rd governor of the Reserve Bank of India (RBI). Mr. Rajan with the full support of then Finance Minister, P. Chidambaram, took several effective damage control measures, and was able to pull the economy and markets out of crisis within a short period of one year. USDINR gained over 11%, stocks markets recorded their all-time high levels, CAD improved to less than 1% of nominal GDP, real GDP growth recovered to ~7% (FY15).

The situation today is nowhere close to the summer of 2013. Nonetheless, the feeling is that we could potentially head to a similar situation in the summer of 2025.

Worsening external situation - rising global trade uncertainties due to the US unpredictable tariff policies, depleting Fx reserves, weakening USDINR, declining FDI and persistent FPI selling, pressure on the government to cut tariff protection for the domestic industry, and rising probability of a global slowdown.

Slowing domestic growth - Prospects of a poor Rabi crop aiding pressuring food inflation and RBI policy stance, crawling manufacturing growth, limited scope for any meaningful monetary or fiscal stimulus, etc are some of the factors that suggest the probability of any meaningful growth acceleration in the near term is unlikely.

Uninspiring policy response – The policy response to the economic slowdown and worsening of external situation is completely uninspiring so far. The measures taken by the government and RBI appear insufficient and suffer from adhocism.

For example, RBI has announced several liquidity enhancement measures in the past three months. These measures have been mostly neutralized by USD selling by RBI to protect USDINR and rise in the government balance with RBI (inability of the government to disburse money quickly to the states or spend otherwise. Risk weight cut for lending to NBFCs and MFI etc. is too little and too late. The damage to credit demand and asset quality in the unsecured segment is already done, and is not easily reversible.

The fiscal stimulus (tax cut on for individual taxpayers) could support the economy if at all, from 2H2025 only. There is a risk that the taxpayers in lower income segments (Rs 7 to 15 lacs) might use the tax savings to deleverage their balance sheets by repaying some of their high-cost personal loans etc. In that case this stimulus could have a negative multiplier on growth.

The short point is that (a) we are yet not in a crisis situation; (b) if not handled effectively and with a sense of urgency, the current situation may not take long to turn into a crisis.

The government, especially the finance minister and RBI, would need to urgently take several steps to take control of the situation and inspire confidence in the businesses and investors. Leaving it to the external developments, e.g., USD weakening due to falling bond yields in the US; energy prices easing due to Russia-Ukraine truce; trade normalcy restoration due to Sino-US trade agreement and normalization of Red Sea traffic; a plentiful monsoon easing domestic inflation; etc. may not be a great strategy - even if it works this time.

As they say – “it is great to have faith in God, but always lock your car”.

Thursday, February 27, 2025

My watch list

Continuing from my previous post (Bull fatigue or bear charge), I would like to share some of the important things I am presently watching closely to assess whether we are passing through a bull market correction or a proper bear market cycle is underway.

Rural income: The recent corporate commentary has highlighted green shoots seen in the rural demand recovery; while the urban demand continues to remain under pressure. For meeting the latest earnings estimates, continued recovery in the rural demand is, therefore, important. Earnings growth of some sectors like consumers, automobile, textile agri inputs & equipment, etc. materially depend on the continued rural demand recovery.

I note that there are some worrisome signs for the rural economy.

First, the 2024-25 winter has been unusually warm and dry. Several states have witnessed drought-like situations and warm weather. Reportedly, Wheat farmers in the northern regions could be staring at a sharp decline in rabi production. Some farmers are expecting upto 50% fall in wheat production due to warmer winter. Pulses and oilseed crops are also feared to be adversely impacted. (see here).

Second, present El Niño-Southern Oscillation (ENSO) weather forecasts are not indicating a strong preference for La Nina (excess rains) or neutral (normal rains) during the Indian monsoon season (July September). These conditions can change materially over the next three months. Given the importance of a normal monsoon for the Indian economy, especially the rural economy, ENSO developments need to be watched closely.

Liquidity: Banking system liquidity bears a good correlation with stock markets. Post Covid-19 monetary and fiscal stimulus resulted in over Rs12.50 trillion of surplus liquidity in the Indian financial system. This massive liquidity surplus resulted in a sharp surge in asset prices, especially stocks and real estate. That liquidity has completely dried. The Reserve Bank of India (RBI) has systematically withdrawn liquidity over the past couple of years. The system liquidity continues to be in deficit despite the measures (50bps CRR cut and Rs1.5 trillion sustainable liquidity infusion through OMO) taken by the RBI. (see here) A further USD10 billion three-year swap (buy/sell) has also been announced to augment the system liquidity.

However, even after these measures, system liquidity continues to be in deficit, as the RBI liquidity injection has been mostly neutralized by USD15bn sale in open market by RBI to check fall in USDINR; and the rise in the government balance with RBI. Given the persistent selling by FPIs in YTD2025 and worsening CAD, the pressure on USDINR may sustain. Under these circumstances, it is important to see how RBI manages to inject sufficient liquidity in the market. A change in policy stance from “neutral” to “accommodative” may be an important hint.

In the global markets, the US and Japan money supply (M2) has started to rise again in 1Q2025 after falling in 4Q2024; while the money supply in China remains at all-time high.

Inflation: The incumbent US President appears to be quite unpredictable. Regardless, his latest actions, in tandem with his commitment to safeguard USA’s economic and strategic interests at all costs, indicate that the US may impose sharply higher tariffs on imports from key suppliers like China, India, EU etc. These tariffs, if not fully absorbed by the suppliers through a mix of currency devaluation and margin adjustments, could be inflationary for the US. Consequently, we may see higher inflation, higher policy rates and bond yields and a much stronger USD. This could eventually be deflationary for the global economy as a whole.

A stronger USD and JPY, and higher bond yields, could result in further unwinding of carry-trades. Emerging markets economies and assets may face strong headwinds.

India, in particular, could be vulnerable due to slowing growth, expanding CAD, declining FDI, higher relative valuations (continuing FPI outflows), slowly depleting Fx reserve, and contracting yield gap with the US, etc.

A poor monsoon, on the back of below par Rabi crop, could halt the RBI easing cycle, as food inflation picks up and food import bill also rises.

It is therefore important to keep a close watch on the US trade policy, and the inflation trends.

Corporate earnings: the past couple quarters have been disappointing in terms of the corporate earnings, triggering a wave of earning downgrades. After the latest (3QFY25) results, Nifty EPS has witnessed 2-3% downgrade. If this trend continues in 4QFY25, the earning downgrades could accelerate. A leading stock brokerage firm (Kotak Securities) now expects Nifty EPS of Rs 1032 in FY25E, Rs 1179 in FY26E and Rs 1348 in FY27E with the Nifty trading at 22.2x FY25E, 19.5 x FY26E and 17.0 x FY27E.

The Nifty valuations are presently close to their long-term average (10yr). However, as another brokerage (nuvama) highlighted, most sectors are already close to their peak margin. Hence the prospects of a PER re-rating are remote, while PER de-rating are real.

Thursday, January 30, 2025

Fed pauses, says not in a hurry to cut more

In a keenly watched two-day meeting, the first after the inauguration of the new US President, the Federal Open Market Committee (FOMC) of the US Federal Reserve (Fed) decided to pause its kept federal fund rates in 4.25%-4.5% range, after cutting it overall by 1% over its three previous meetings. The decision to pause is governed by a strong and resilient labor market and persisting inflation.

In a post meeting press interaction, Fed Chairman Jerome Powell noted that “The unemployment rate has stabilized at a low level in recent months, labor market conditions remain solid, and Inflation remains somewhat elevated.” He further added that the Fed needs to see “real progress on inflation or some weakness in the labor market before we consider making adjustments.”

Most notably, he emphasized that we're meaningfully above the ‘neutral rate’. He said, “I have no illusion that anyone knows precisely how much that is and but having cut 100 basis points means that it's appropriate that we not be in a hurry to make further adjustments.” (‘Neutral rate’ is a fed rate that is considered neither stimulative nor restrictive of growth under the current circumstances.)

Higher for longer: The market participants have taken this to imply that the current rate cut cycle is certainly not over and may resume after a pause, as the Fed gathers more evidence on inflation. Nonetheless, analysts now appear less sanguine about the lower bound of the present rate cut cycle. The consensus amongst them is emerging that the long-term bottom rate may have risen to 3% from the earlier estimates 2.5%. The ‘Fed pause’ is also being influenced by uncertainties surrounding the new administration's direction - on fiscal, trade, and government spending matters. The Fed officials noted “they don't intend to react until policies reach the implementation stage and begin to impact incoming economic data”.

Markets: Post the Fed decision, stock prices ended lower (S&P500 -0.5%), USD marginally stronger (DXY +0.2%) and benchmark bonds stronger (US 10yr Yield -0.37%).

RBI: The ‘Fed pause’ has made the February 06^th rate cut by the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI), less certain. There are however more chances that RBI may change its stance to ‘accommodative’ from ‘withdrawal of accommodation’, signaling now growth is a priority over inflation.

Thursday, December 19, 2024

Cautious FOMC spoils the Santa party

The Federal Open Market Committee (FOMC) of the US federal Reserve (Fed) obliged the market consensus by cutting its overnight borrowing rate by 25bps to a target range of 4.25%-4.5%. One member of FOMC voted against the cut, preferring to maintain the status quo.

Noting the economic conditions, especially still elevated inflationary expectations and resilient growth, the Fed indicated that 2025 may see fewer cuts than the previously estimated number. “With today’s action, we have lowered our policy rate by a full percentage point from its peak, and our policy stance is now significantly less restrictive,” Chair Jerome Powell said at his post-meeting news conference. “We can therefore be more cautious as we consider further adjustments to our policy rate.”

The FOMC raised its projection for full-year 2024 GDP growth to 2.5%, from 2% in September. However, in the following years, the FOMC officials expect GDP to slow down to its long-term projection of 1.8%. The committee lowered its expected unemployment rate in 2024 to 4.2%, while headline and core inflation were pushed higher to 2.4% and 2.8% respectively, slightly higher than the September estimate and above the Fed’s 2% goal.

The resilient growth and elevated inflationary expectations would require the Fed to hike or hold rates in 2025. However, officials appear wary of keeping rates too high and risking an unnecessary slowdown in the economy.

Insofar as the Trump 2.0 policies and their impact on the growth are concerned, the Fed Chairman Jerome Powell prefers a wait and watch approach. IN the post FOMC meet press interaction he said, “We’re just not at that stage.” He further added, “We need to take our time, not rush and make a very careful assessment, but only when we’ve actually seen what the policies are and how they’ve been implemented.”

The financial markets reacted negatively to the FOMC decision. Dow Jones lost 1123 (2.58%). Falling for the tenth consecutive day, it has recorded its worst losing streak since an 11-day slide in 1974. The S&P500 (-2.95%) and Nasdaq Composite (-3.56%) fell even more. The benchmark 10-year treasury yields jumped 3.08% to 4.52%, the highest level since April 2024 and 90bps higher than their August 2024 lows. UST Index rose 1.2% to its highest level in almost three years. Gold prices fell 2.3%, taking the yellow metal below US$2600 level after 3 months.

Wednesday, October 16, 2024

Some random thoughts

Myth of free market

A fundamental principle of economics is that “in a ‘free market’ current price of anything having an economic value is a function of demand and supply of such things at that particular point in time.” Of course, there could be multiple factors that may impact the demand and supply of a thing; but usually nothing impacts the “price” directly other than the forces of demand and supply.

In a ‘controlled and/or manipulated market’ the prices of things are fixed by the controlling authorities (or forces); regardless of the demand and supply for such things. In such markets, usually demand and supply of things are controlled and/or manipulated; or demand and supply duly get adjusted to the fixed/manipulated prices.

In the modern world, money is arguably the largest factor of production in the world. The price of money (interest rate) should ideally be a function of demand and supply of money. In case of excess supply, the interest rates should be lower and vice versa.

If we apply this core principle of economics to the world around us, we may discover that a significantly large part of global markets is presently either controlled or manipulated. The free market may only be prevalent in textbooks now. It has been completely obliterated from the political speeches across the world; and is also being systematically removed from the policy documents.

The US Federal Reserve can simply manipulate the supply of the USD to influence the prices of bonds, goods & services denominated and settled in USD. An axis led by China and Russia is emerging to weaken the powers of the US to manipulate the global markets through controlling supply of USD. So far, it is more of an intention. There is no work-in-progress evident on the ground.

Removing all doubts

Notwithstanding all the grandstanding, global preaching, and progressive narratives, the US has mostly been a racist and sexist society. For many decades there was a pretense on part of the US politicians to present it as an inclusive, liberal and free society. In the ongoing elections the pretense has been shed. There is a conspicuous effort to make the contest between a Right wing, “white” supremacist “man” and a “woman who happens to be “black”.

Confidence of RBI

In its latest monetary policy report, the RBI has expressed strong confidence in the Indian economy. It projected the real GDP growth of 7.2% for FY25. It also sees the growth momentum sustaining in FY26 with 1QFY26 of 7.3%.

On the other hand, the brokerages are projecting material slowdown in profitability growth. The corporate tax collections for FY25, so far, are down 6% yoy. The core sector growth has collapsed to many months low in August. The capital expenditure of the states in FY25 is projected to be less than even FY23. The central government spending which has supported the growth since FY21 is also tapering. Private capex has picked up but is mostly related to asset (land and building) acquisition rather than enhancing productive capabilities.

I wonder where the confidence of the RBI is flowing from! Is RBI relying too much on the forward looking surveys indicating better business and consumer confidence for the future despite conspicuous deterioration in the current conditions? Or is there something not known to the markets; just like Haryana election results where CM Saini could clearly see what no one else saw.

INR, yields and rate cuts

RBI has apparently let go of the USDINR 84 level, which it was allegedly defending for almost a year. The FPI outflows are accelerating every week. The US0 India yield gap is narrowing, further raising the specter of accelerated outflows.

The benchmark US yields (now 4.10% rising 40bps after aggressive 50bps rate cut by the US Fed) and mortgage rate (now over 8%) have not behaved on the expected lines.

In India also there is almost a consensus over a repo rate cut in December. The MPC members might however be wondering whether it is desirable to waste one important arrow in their quiver at this point in time when there are ample indications of a crisis like situation emerging in 2025, requiring aggressive policy support. Given the market condition, a rate cut may not be passed on the borrowers as banks are already struggling with credit-deposit growth mismatch. The benchmark yields have already eased in anticipation of a cut and may not ease much post the cut. In any case, the RBI may not like the US-India yield spreads to narrow further, further pressurizing USDINR.

Tuesday, September 24, 2024

Are you feeling chill in the air

The Fed, BoE, and BoJ rate decisions are out of the way now. The S&P500, bond yields, USD, JPY, Gold, and Bitcoin, etc. have already made their initial move. The market participants may now begin to focus on elections – state assembly elections in India and the US Presidential elections. Regardless of overwhelming evidence to suggest that these elections may not impact the markets beyond a few days, the narrative might keep the market participants busy and distracted in the next few weeks.

I find many events, besides rate cuts and elections, that are occurring on the sidelines that need to be noted by the investors. Considered individually, these events may not look like triggering a meaningful move in global markets. However, if we take a collective cognizance of these events, the probability of global market shock would certainly rise by a few points.

The following events, for example, have drawn my attention in the recent months.

Central banks loading on gold

Post the global financial crisis 2008-2009, the central banks have significantly increased their gold accumulation. In 2023, central banks added 1,037 tonnes of gold – the second highest annual purchase in history – following a record high of 1,082 tonnes in 2022. The trend is continuing in 2024 also. (see here)

The notable thing in this trend is the sharp rise in gold accumulation by the Russian and Chinese central banks. President Xi and President Putin, along with Iran and North Korea (CRIK) are seen as an informal anti-NATO alliance. (see here)

Biden provides fresh impetus to the Sino-US tariff war

The Biden administration has provided significant impetus to the Sino-US tariff war started by the Trump administration. Despite strong objections from the domestic industry, the US has not only retained the tariffs imposed on the Chinese imports by the Trump administration in 2018, but made some material additions to the list. The new tariff list includes a 100% duty on Chinese EVs, 50% on solar cells and 25% on steel, aluminum, EV batteries and key minerals.

Besides, the Biden administration announced new measures aimed at Chinese e-commerce platforms to minimize the low-value imports eligible for duty and tax exemptions. (See here)

Putin mediating thaw between India and China

The rhetorical aggression between China and India has decelerated materially in the recent weeks. It is reported that China is retracing from its advanced positions in the Indian territories and willing to disengage completely. Apparently, it has occurred after the recent visit of PM Modi to Russia and Ukraine. (see here) This is obviously an important geopolitical development after the coup in Bangladesh, allegedly with support of the US. (see here)

Hedge Fund piling on short positions

In the past few weeks hedge funds have been piling on their short positions. They have now been net sellers for the five consecutive weeks, not a normal situation when the benchmark indices are making all-time highs.

Chinese economy imploding, govt puts a tight leash on investment professionals

All the recent data about the Chinese economy indicates that the Chinese economy is slowing much faster than previously estimated. As per the current estimates, China is most likely to miss even a modest 5% growth target. (see here) By all indications the Japanification of the Chinese economy is happening against the wishes of all. The Chinese economy has been the engine pulling the global economy in the past two decades. If this engine falters, it cannot be good news for the global economy and therefore markets.

The Chinese authorities have been taking action against the entrepreneurs, like Jack Ma of Alibaba, failing to adhere to the strict regulatory norms. Recently, the authorities cracked down on financiers – impounding passports of 8700 investment bankers and restricting their overseas travel. (see here)

This could be seen by some as a precursor to a massive shift in the economic development followed in the past two decades. (see here)

Traders incurring losses despite market rally

On 12^th September 2024 (weekly F&O expiry day), many option traders in India experienced exceptional losses due to sharp surge in the benchmark indices in the last hour of trading. It happened again last Friday. This has happened when sharp underperformance of the broader markets and popular stocks is already bothering the non-institutional (retail) investors. In the technical analysis parlance, these are conspicuous signs of a large-scale distribution taking place. Empirical evidence suggests that this phase of the market is usually followed by a dull period in the market, marked by poor returns.

It's still the month of September and on my morning walks, I can feel the chill in the air. This is not usual weather in Delhi NCR. I am getting the same sense in markets. If you are also feeling this chilling sensation, please do share your views.

Thursday, September 19, 2024

Fed covers ground with a stride, does not look in a rush

Ending the weeks of intense speculation, anticipation and debate last night, the Federal Open Market Committee (FOMC) of the US Federal Reserve started the latest monetary easing cycle with a 50bps fund rate cut. The Fed fund rate range now stands at 4.75-5.00% This is the first Fed rate cut since March 2020 and has come after a fourteen months policy pause.

No panic in the boardroom

Unlike the previous two rate cycles that started with a rather aggressive 50bps rate cut – first October 2008 post the Lehman collapse and second March 2020 post Covid-19 break out – this cut is apparently not a panic cut.

The Fed chairman sounded confident about growth and employment level. He emphasized that the central bank is not in a hurry to ease policy, as he sees no likelihood of an elevated downturn in the economy. He mentioned, “There’s nothing in the SEP (Summary of Economic Projections) that suggests the committee is in a rush to get this done.”

The Chairman categorically advised the markets to not take this 50bps cut as “new pace”. He said, “we’re going to go carefully meeting by meeting, and make our decisions as we go”.

The decision to cut was however not unanimous. In a rare dissent, one member (Michelle Bowman) voted for a 25bps. This could be seen as yet another sign of “no panic” in the Fed board room.

Committed to price stability without pain in labor market

Announcing a victory over inflation, Mr. Powell announced, “The U.S. economy is in good shape. It is growing at a solid pace. Inflation is coming down.”

As per the latest economic data release, the US GDP expanded at 3% annual rate in 2Q2024 with 4.2% unemployment rate (considered near full employment), and inflation at 2.2% in August 2024.

Outlining the latest policy objectives, he commented, “We’re trying to achieve a situation where we restore price stability without the kind of painful increase in unemployment that has come sometimes with disinflation”. Guiding the markets, he emphasized that investors should take the Fed’s 50bps rate cut as a sign of its “strong commitment” toward achieving that goal.

Neutral rate seen close to 3%

The FOMC members see cuts of 25bps each in November and December FOMC meetings; 100bps cut in 2025 and 25bps cut in 2026 – implying that the latest easing cycle may end with the Fed rate range of 2.75-3.00%.

The Fed Chairman also mentioned in the post FOMC press meet that the neutral rate is likely significantly higher than it was on the previous occasions.

Markets ended lower

Markets – equity, bonds and commodities – ended the day with marginal cuts post the Fed announcement; while the USD was marginally stronger. This could be an outcome of either (i) sell on news; or (ii) traders’ disbelief in what Fed says about the strength of the economy.

What now

In my view, this aggressive 50bps cut is more of a correction than an aberration. Perhaps the Fed realized that they are running slightly behind the curve and hence tried to catch up. I do not see it as a panic move and would not like to indulge in “there is more to it than what meets the eye” debate.

Unlike 2008, there is no corporate balance sheet crisis, no risk of global markets freezing, and unlike 2020 there is no shutdown necessitating fiscal and monetary profligacy. It is a normal rate cycle change in response to a normalizing economic cycle. Therefore, expecting a market reaction like 2008 (sharply down) or 2020 (sharply higher) may not be appropriate.

I feel the US markets will adjust to the new policy trajectory in a couple of weeks and move accordingly. The lower rates shall help arrest the decline in the US housing markets and consumer spending. The bond yields may come down and the hedge trade in gold may begin to unwind. The corporate discretionary spend may also normalize as the cost of borrowing eases. This could be a relief for the Indian IT services companies.

For India, I am not sure if the RBI will rush to cut in October meeting, but would not rule it out completely. Financials and commodities are two sectors that need to be watched closely, in my view.

In the next couple of months, the markets in India will be driven by the 2QFY25 earnings. Any disappointment could lead to a decent correction in the markets. For now, I do not see a need to make any change in my investment strategy. (More on this next week)

The major risk to the markets comes from geopolitics now. The situation in the Middle East is worsening by the hour. NATO and CRIK (China, Russia, Iran and North Korea) alliances are hardening their positions, both on trade and war, making the situation explosive. (More on this next week)

Wednesday, September 18, 2024

Anxious, stressed and desperate

The life of equity investors appears to be becoming more tense with each passing day, regardless of the indices scaling new highs. This applies more to the professional investors (fund managers etc.) as compared to the individual investors. I gather from my conversations with the professional investors that they are finding it increasingly difficult to sustain their performance of the past three years.

The assets under their management (AUM) have increased multifold in these three years, but the stock of quality investable equity shares has not grown at a matching pace. Some of them have been reluctantly deploying the incremental flows in the limited number of available stocks, resulting in unsustainable rise in prices; whereas the others have chosen to go down the quality ladder and invested in the poor quality or apparently absurdly valued stocks.

Obviously, they lack conviction in their portfolios, but continue to hold it and even grow it due to professional compulsions. Arguably, they are riding the proverbial tiger with no end in sight for the ride. No surprises that they are stressed and desperate at the same time.

Individual investors on the other hand appear bothered by concerns, which have mostly emanated from psychological factors, perceptions and overflow of news flow and analysis. For example-

· The popular stocks which led the market rally in 2021-2023 (specialty chemicals, railway, defense, PSU banks etc.) have been underperforming in recent months. The investors who have material positions in these stocks are suffering from “other queue always moves faster” syndrome. Their anxiety is further elevated by the fact that the sectors like IT Services which were most undrowned in 2023 have recently done exceedingly well.

· Most investors have apparently internalized the exceptional returns they have earned in the post Covid period into their normal portfolio return projections. The analysts are now forecasting the market returns to revert to mean over the next couple of years, as the operating leverages fade and corporate debt begins to rise again, economic growth plateaus, and earnings growth trajectory descends to mid to low teens. Many investors are not finding the idea of 10-12% return on their equity portfolios exciting enough.

· The news flow and analysis are becoming increasingly confusing for them. In the evening, they hear that the imminent rate cut by the US Fed is likely to drive the global markets higher. However, in the morning they are presented with analysis of how the past episodes of Fed rate cuts have triggered sharp corrections in equity markets.

A host of analysts advise them to invest in gold; then some expert comes and tells them silver will do much better in the coming years as the demand for EV batteries and semiconductors rise. Credit analysts claim that bond returns shall outperform equities in a falling growth & rate scenario. There is no dearth of analysis on how cryptocurrencies are going to annihilate gold.

· There is persistent fear mongering of WWIII led by Russia and China. Astrologers are predicting retrograde Saturn, Jupiter and Mercury in the winter of 2024 could cause a massive crash in markets.

While all this is agitating the investors’ mind, an IPO lists at 135% premium to its issue price, luring them to allocate even more money to equities!!