Is inflation set to collapse?

Even otherwise, the country hasn’t experienced price rise as severely as its global peers, they noted. “Domestic food prices and a delayed recovery helped India to avoid double digit consumer price inflation,” they wrote.

Structural inflationary drivers are absent in the country, they noted, pointing to the credit gap, which is still in the negative. "That means, there is more room in the economy for credit expansion and the current credit surge won't be inflationary," said Ankita Pathak, Product Manager and Macroeconomist at DSP Mutual Funds, and one of the authors of the report, in an interaction with Moneycontrol.

Other signals

While elevated fuel prices cannot be ignored, the analysts reason that the rate of oil consumption by India and China–which are the two countries that drove 59 percent of the incremental demand in the commodity–will begin to lessen. In the next ten years, the analysts see the countries’ growth rate slowing down and therefore oil-demand growth decelerating. “Therefore, even maintenance of CAPEX (by oil producers) could be a threat to prices,” they wrote.

The US 10-year-2-year yield curve has inverted more sharply than it has ever before in the 21st century. This would suggest that the market is expecting a slowdown in growth. The authors cite past data to show that inflation has always fallen after this yield curve inversion, and that fall is yet to happen though inflation has risen to decadal highs.

Also read: Has the relationship between inflation differentials and exchange rate movement broken down?

How to invest

To get ahead of this curve, the authors suggest investors make duration plays in bonds, and commodity users such as auto, cement and consumption. With inflation falling, there will be higher disposable incomes and greater credit growth, and therefore banks will be a good bet too, according to the authors.

By duration play in bonds, they mean investing in high-duration bonds. As of now, their fixed income team prefers to invest in medium maturity (4-6 years) and keep part of the portfolio in low maturity (<1 year) but they are on the lookout for long-duration plays as inflation cools and central-bank forward guidance changes. "When rates stagnate or fall for the long-term, then capital gains start on long-term bonds," said Pathak.

Autos have had to increase prices to unprecedented prices--8 to 10 percent, when their usual is 2-4 percent--but despite that they could only pass on price hikes partially, according to the report authors. When commodity prices falling, OEMs will see their margins recover. Cement producers too have been taking a massive hit on their margins, with fuel (petcoke, coal and diesel) prices rising. According to the authors, this is a clear indicator that they haven't been able to pass on the prices to their customers, and therefore any fall in the fuel basket will be like "manna from heaven for the sector".

Banks because there is a strong demand for credit and banks are able to price loans better. Added to that the banks have healthy balance sheets with adequate provisioning, and they are priced below 2x, reasoned the report.

Risks to the outlook

Their forecast on inflationary trend reversing isn’t without risks. The biggest of the risks they see is an escalation in the Russia-Ukraine conflict that could drag in NATO, and lead to a sustained period of high energy prices. Secondly, if demand does not weaken because the slowdown hasn’t led to deep fall in employment, then consumption could remain strong and delay the cooling off of core inflation, according to the report. The third is a low-probability event of China infusing a massive stimulus to revive growth, which could result in a steep hike in commodity prices.