The deepening crisis in the Middle East and the consequent geopolitical tension remain a source of uncertainty for markets around the world with the prices of crude oil and investor sentiment being hit hard. The focus at the moment remains on the actions taken by the major central banks, especially the US Federal Reserve as inflationary pressures continue to build up, says Milind Muchhala, executive director at Julius Baer India.
Julius Baer is of the view that the US economy will achieve a ‘soft landing’, but one risk scenario to the ‘soft landing’ view is a sharp rise in long-term interest rates well above 5.5 percent.
Coming to India, the equity and wealth management veteran for the 20 years says that industrials and infrastructure could be a bright spot in the September FY24 quarter. Excerpts from an interview to Moneycontrol:
After reading the latest speech by Fed Chair Powell, do you think the Fed will stick to its 2 percent inflation target and will go for one more rate hike before taking a long pause at least till end-2024?
The Fed seems to be in a slightly tricky situation at this juncture. At one end, while the goods disinflation is providing some respite, the recent geopolitical scenario and oil supply disruptions have led to uptick in oil prices, thereby putting upward pressure on inflation. The rent inflation also surprisingly increased in September, leading to unsatisfactory inflation report and the impression that overall disinflation stalled in September, while the US labour market (as reflected in the non-farm payroll) also surprised with stronger employment growth, masking underlying rebalancing.
This, to some extent, increases the probability that Fed officials see the current policy rate as not restrictive enough. On the other hand, the long-term interest rates have seen a sharp rise recently, with the 10-year US treasury yield crossing the 5 percent levels, a 16-year high. Consequently, it has already tightened overall financial conditions and is partly offsetting the pressure on the Fed to make the policy more restrictive.
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Our global desk is of the view that lower inflation numbers in the coming months and a softer labour market with wage growth moderating can prevent the Fed from hiking the rates further in the upcoming policy meetings. However, even as the tightening phase winds down, the central banks are expected to maintain their higher policy rates, resulting in a ‘higher for longer’ interest rate scenario.
Some experts and economists are saying that the US could dive into deeper recession in the long term...
The US economy has endured a 525bps tightening cycle, a sharp collapse of housing affordability, and a significant tightening of financial conditions. Despite these monetary headwinds, the US economy remains surprisingly resilient. Solid investment demand despite stricter financial conditions, helped by a supportive fiscal policy and imperatives ranging from reshoring to clean energy production, is changing the investment/savings balance, resulting in structurally higher interest rates.
The increase of long-term interest rates is a limiting factor for economic growth, but tailwinds such as supportive fiscal policy and sanguine investment plans can offset rate-related headwinds at current levels. As consumption makes up more than two-thirds of the economy, a resilient consumer with healthy balance sheets and continued good labour market opportunities, is likely to be able to stem an economic contraction or experience it only mildly.
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Recent economic data support our global desk view that the US economy will achieve a ‘soft landing’, while the disinflation process remains intact (with core inflation moving lower) even if it unfolds in non-linear fashion. One risk scenario to the ‘soft landing’ view is a sharp rise in long-term interest rates well above 5.5 percent.
More than 50 percent of Nifty50 earnings for the September quarter have been announced. How do you see it?
The Q2FY24 results announced till now have largely been in line with estimates (at least in terms of profit growth), with no major surprises or shocks, although these are still early days, and a number of heavy weights across sectors are yet to report numbers. The numbers till now have primarily come from the Financials, IT and Consumption space. Hence, we will get a clearer picture on the earnings trajectory only in the next couple of weeks, whether any large changes to the overall estimates for the year are warranted.
On the sectoral front, most of the Banks/NBFCs have delivered a decent set of numbers, although the NIM (net interest margin) pressure was visible on a sequential basis, a trend expected to continue as the liabilities get repriced. The IT sector has been some sort of a mixed bag with the midcap names delivering better than the largecap peers. While the deal wins/pipeline remain quite healthy, the uncertain macro environment and delays in project ramp-ups has led to some truncation of revenue growth guidance.
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Consumption is clearly one space that remains under a lot of pressure, with weak volume growth amid softness in demand from value segment and rural markets. While the decline in input costs is a positive, aiding margin improvement, while also remaining a catalyst to drive volume growth (as the companies pass on the benefits to consumers), especially amid the festive season, the uneven rainfall and increasing competition from local/regional players emerge as headwinds.
Industrials and infrastructure could be a bright spot in this quarter, benefiting from the healthy revival in the capex cycle, momentum in real estate sales and robust spends by the government on infrastructure.
After reading management commentaries following quarterly earnings, what is your outlook on the companies' performance for the second half of FY24?
The second half of FY24 is expected to be largely similar to the first half, although it should be more constructive for some sectors such as Consumption on expectations of a better demand environment, especially in the rural markets. The festive season this year saw some sort of a push back to Q3 versus occurrence of some of the festivities in Q2 in the previous year.
Moreover, as we move closer to the elections, the government could take a slightly more populist bend. Hence, these should be driver of improved performance by the consumer-oriented companies. We also saw some front-loading of the capex by the Government in the first half; hence this can see some tapering and have implications for the early-cycle industrial companies.
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The globally oriented companies could continue to see mixed trends, mired by yet uncertain global environment.
Do you really see the significant uncertainty for the equity markets due to geopolitical tensions?
Geopolitical tensions definitely remain a source of uncertainty for the markets, especially considering the implications that it could have on crude oil prices and overall sentiment. However, currently the focus remains on the actions by the central banks, especially the US Fed, amid the build-up of inflationary pressures.
The global market in the past few weeks is witnessing some sort of a risk-off environment, leading to selling by FIIs in global equities, and Emerging Markets (EMs) in particular. Indian markets had witnessed significant outperformance over the past few months; this, coupled with an uneven monsoon, slight deterioration in the macro data, upcoming elections in a few States, and significant valuation premium could have prompted profit booking in India amid an uncertain global environment.
The volatility can be much more magnified for the small/microcap space in case the liquidity flows were to get challenged.
Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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