Moneycontrol Pro Panorama | The inflation tanker’s beginning to turn

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Dear Reader, 

The Panorama newsletter is sent to Moneycontrol Pro subscribers on market days. It offers easy access to stories published on Moneycontrol Pro and gives a little extra by setting out a context or an event or trend that investors should keep track of. 

The mighty rate increases introduced by the US Federal Reserve, in big chunks of 75 basis points, seem to be doing their work. Consumer inflation rose by only 7.7 percent in October over a year ago and by 0.3 percent over September. The relief stems from economic soothsayers getting their calculations wrong as their estimates were higher, but the market spins that into a win saying expectations were beaten. For the record, the increase over a year ago was the lowest since January.

In some ways, that’s an incredible outcome for the markets and indeed for the US Federal Reserve. The central bank has been in a whatever-it-takes mode when it comes to inflation, and that approach, to the exclusion of other economic priorities, seems to be working. That may explain why in the November FOMC (Federal Open Market Committee) meeting, the Fed had dropped hints about future rate hikes going below the 75 bps mark.

But they also confused us, as Fed chair Jerome Powell also spoke about interest rates peaking at a higher than expected level and rates could remain higher for longer than expected. That poured cold water on investor hopes, but yesterday’s inflation print has pushed those concerns right to the back.

US stocks ‘roared’ on Thursday, reported the FT, having their strongest day in two and a half years. The S&P 500 gained by 5.5 percent and the Nasdaq by 7.4 percent. Futures are pointing to a bright day on Friday as well. Its impact is being felt in the domestic market as well. The rupee is up and so are equities, with the Sensex up by a smart 1.8 percent, 8 percent from a month ago.

The question we will seek and hopefully find answers to, in the coming weeks and months, is if it’s enough if the Fed brings down the size of rate hikes, even if it keeps at it for a long time. One of the more important factors to watch, says this Bloomberg report, is Friday’s print on 5- and 10-year inflation expectations.

If we can agree that one part of equity valuations is also dependent on fundamentals, then can we ignore the effect that higher interest rates for long will have on earnings? After all, when the Fed uses terms like a softer labour market and lowering inflation expectations, rate hikes are a blunt hammer. The higher cost of money will work its way through the economy, pulling back demand and pushing up supply, which brings prices down.

That’s already visible in the US economy, in the housing market and in the tech sector, for example. During the go-go days, the tech companies were being hailed as future-proof investments. They were the future. But that vision is turning sour now, with their market cap losses making news and, for their employees, job losses are staring them in the face. It’s one thing when their founders see their paper wealth erode, but when livelihoods are lost, the repercussions are far wider. All of the big picture thinking that went behind extravagant investments and hiring has been consigned to the deleted folder in the cloud. As this FT report says (free to read for subscribers), “With the turning of the interest rate cycle, all of these incentives (to invest and hire) have evaporated. The only question now is how widely this has sunk in.”

While the tech companies may have been among the first to be affected, others will join the queue too. After all, that’s what the Fed wants. Economic activity has to slow down for inflation to come under check and if inflation is coming under check, then the slowdown will become visible too. When that flows down to earnings, growth warnings and lowered guidance, will equities still be in the clear? Soon, talk of a soft landing will head your way as people will wonder if the Fed can pull off a miracle.

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(These are published every trading day before markets open and can be read on the app).

Ravi AnanthanarayananMoneycontrol Pro