Moneycontrol Pro Weekender: Do gentlemen really prefer bonds? 

The Flash or advance PMI surveys for September show the economy slowing dramatically in Europe and the UK

Dear Reader,

In the late 1920s, when asked a question about investing in overvalued US equity markets, former US Treasury Secretary Andrew Mellon famously quipped, “Gentlemen prefer bonds.” More recently, with persistent inflation and central banks intent on keeping rates higher for longer, not just gentlemen but most investors seem to have revised that opinion. The Bank of America survey of global fund managers earlier this month found that investors were once again underweight bonds for the first time in seven months.

With good reason. Bond yields reflected the spate of central bank announcements this week. The big story, of course, was the US 10-year Treasury yield touching 4.5 percent briefly for the first time since 2007. That happened despite US Fed chair Jerome Powell not hiking rates—his hawkish rhetoric was enough to force both bonds and equities down. In France and Germany, bond yields moved up, but only a bit, despite ECB chief Christine Lagarde raising the policy rate by another 25 basis points, amid signs that the peak has now been reached. In the UK, the Bank of England held the policy rate steady and the 10-year gilt yield fell during the week, as the market was expecting another hike. The Bank of Japan held on to its ultra-low rate, despite inflation being well above its target, aided and abetted by a plunging currency.

Why the different reactions in the bond markets? The Bank for International Settlements had an answer. In their latest Quarterly Review, they said, “While US long-term yields reached highs not seen since before the Great Financial Crisis, such yields barely rose in the euro area. These dissimilar paths were driven by inflation-adjusted, i.e. real, yields consistent with a stronger economic outlook in the US than in the euro area.”

Indeed, the Flash or advance PMI surveys for September show the economy slowing dramatically in Europe and the UK. In the Eurozone, the Flash Composite PMI, a yardstick of private sector activity in both manufacturing and services, came in at 47.1, implying contraction from the previous month. (A reading below 50 indicates economic activity shrinking compared to the previous month). For France, the composite PMI was at 43.5, a 34-month low. Germany’s PMI ended the third quarter of the year deep in contractionary territory. No wonder, Lagarde is being lambasted for hiking rates in the middle of a slowdown. The Flash PMI for Japan showed slower growth and weaker inflation. In the US, the flash PMI at 50.1 is barely in expansion territory.

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Manas Chakravarty

Group Consulting Editor|Moneycontrol

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We had, at the beginning of the week, said in our Market Outlook column that central bank decisions were key for market direction during the week, but also pointed out that Indian markets were showing clear signs of fatigue.

After the Fed meet, this Financial Times report (free to read for Moneycontrol Pro subscribers) said the Fed had hardened its commitment to a higher-for-longer scenario for interest rates. Interestingly, the Federal Open Market Committee has now projected the Fed Funds rate at 5.6 percent by the end of 2023 (median forecast), the same projection as made in their June meeting and upped the forecast for end-2024 to 5.1 percent from 4.6 percent in June. The markets don’t really believe that and are pricing in a 54 percent probability of the policy rate remaining the same as now at end-December this year. As for end-December 2024, it’s far too early to forecast, but the market at present is evenly divided on whether the Fed Funds rate will be 4.5-4.75 percent or 4.75-5 percent -- the probabilities are around 26 percent each. The current Fed Funds rate is 5.25-5.5 percent.

The FOMC projections should be taken with a large dose of salt. In March this year, the median projection for 2023 real GDP growth was 0.4 percent, for unemployment at year-end at 4.5 percent and the Fed Funds rate at end-December at 5.1 percent. Now, GDP growth is forecast at 2.1 percent, unemployment at 3.8 percent and the Fed Funds rate prediction at 5.6 percent.

But we shouldn’t be too harsh on them, as uncertainties have increased sharply. This FT story says, “Pity our central banks. Having been forced into a highly concentrated hiking cycle after mis-characterising inflation as “transitory”, they are uncertain about how much of the “long and variable” impact of tighter monetary policies have already played out in the economy. Their confidence in projections that have been consistently off the mark has withered.”

Neither the OECD nor the ADB, which came out with their interim economic outlooks this week, forecast a recession in the advanced economies. Indeed, this FT story said many economists “worry that underlying momentum in the world’s largest economy is still too strong and that inflation will become harder to root out”. The OECD report, which forecasts lower global growth next year, predicted a US rate cut of 25 basis points in July next year and another one in October 2024. A global recession is not priced into equities and could have a big impact on markets if it happens.

For India, this week was a landmark for the bond markets, with JP Morgan announcing the long-awaited inclusion of Indian bonds in the Government Bond Index-Emerging Markets (GBI-EM) indices. The inclusion will begin from June 28, 2024, and follow a staggered approach of 1 percent increase in weightage per month over 10 months, until India reaches the maximum weight of 10 percent in the GBI-EM Global Diversified index. This will be the trigger for passive index flows to India and the upshot is likely to be lower bond yields, a lower cost of borrowing for the government and upward pressure on the rupee. In fact, bond yields fell on the news before the knee-jerk reaction faded and the rupee strengthened a bit. Lower yields will be good news for corporates and the markets, but much depends on crude oil prices, the strength of the dollar and US bond yields. Inclusion in the international bond indices should also help the corporate bond market as government bonds find another set of buyers and there is thus less crowding out of corporate bond issues. Also, the prospect of international buyers will lead to greater fiscal discipline.

What then should Indian investors do? My colleague Anubhav Sahu had this to say: “We believe the risk-reward in terms of investment is tilted in favour of large caps. It would be prudent to look at mid caps and small caps on a case-by-case basis only.” In the same vein, our columnist Ananya Roy advised long-term investors to buy quality stocks on dips.

Cheers,

Manas Chakravarty

Here are some of the other stories and insights we published this week, apart from our technical picks in the equity, commodity and forex markets:

Stocks 

Which is the best stock to play the booming capital markets?

Tata Steel, Borosil Renewables, Triveni Engineering, Signature Global IPO

This auto component maker is cruising along with higher aluminium play, Dabur India,

Ujjivan SFB,  Manoj Vaibhav Gems & Jewellery IPO, Weekly tactical pick: this auto company has a long way to go.

Markets 

In the Money, OECD forecasts Fed Funds rate to remain at current levels till July next year

Do traded volumes matter in a falling market?

Rising Offers for sale and promoter selling a red flag for the market

Look for pockets where earnings are depressed to find value buys: Sage One’s Samit Vartak

Financial Times 

We shouldn’t call ‘peak China’ just yet

Lex | Private equity: financial engineering prevents valuation check

Companies and industry 

Tata Steel UK, Tea may bring cheer to FMCG players in FY24, but at the cost of growers

Will FMCG stocks skid or steer through the oil price spike?, HDFC Bank, Tech Mahindra’s rebound trade

Revenue density of apparel makers below pre-pandemic levels

Cipla acquisition plan a risky proposition for Torrent Pharma

Personal Finance 

Debt funds: Should you try duration strategy or opt for predictable returns?

Nifty at 20,000: BAF fund managers cut equity exposure, shift to large-caps

The nitty gritty of travel insurance

Geopolitics 
The Eastern Window: The surreal rise of Xi Jinping Thought

Can the WTO stay relevant in a multipolar world?

Startups and Tech 

Wipro, Tech Mahindra, Infosys ride generative AI wave; see up to 30% productivity jump

How startups can navigate through sudden regulatory changes

Private credit AIFs offer appealing risk-reward equation to investors: Shekhar Daga, ICICI Prudential AMC

Economy & Policy 

Is oil at $100 a barrel round the corner?

Are households borrowing more to fund consumption?

Proposed Competition Regulations: A lawyer’s dream but a nightmare for businesses?

Having more women MPs, MLAs not enough to improve status of women

Record imports to keep a lid on edible oil prices

The new India story: Jobless growth, and a rising disconnect between education and employment

Monsoon Watch

Others 

Guruspeak| How Firoz used ChatGPT to turn into a profitable trader

DMK’s Sanatan dilemma

Marketing Musings: Why do some iconic brands thrive and yet some fall by the wayside?