Moneycontrol Pro Weekender: Immaculate disinflation?

There are hopes that lower inflation will lead to the revival of rural demand, which will boost FMCG stocks.

Dear Reader,

Economist Paul Krugman is credited with coining the term ‘immaculate disinflation’, meaning disinflation without an increase in unemployment. The objective of hiking rates is to cool the economy so that inflation comes down. But with the unemployment rate at a mere 3.4 percent in April and inflation down to 4.9 percent, disinflation in the US has so far been painless, though the beleaguered regional banks that are seeing a slow run on their deposits are unlikely to agree.

What about India? Retail inflation for April came in at 4.7 percent year-on-year, the lowest since October 2021, thanks largely to the base effect. Food inflation fell, again because of the base effect. But month-on-month retail inflation moved up from 0.23 percent in March to 0.51 percent in April, while food inflation month-on-month also moved up, indicating that price pressures continue, despite the year-on-year optics.

Similarly, while the CMIE Core Core index, which excludes the food, fuel & light group and fuel for vehicles, fell from 6.2 percent in March to 5.9 percent in April, the fact is that this yardstick went up month-on-month from 0.27 percent in March to 0.58 percent in April. That indicates companies still have pricing power.

Also, if the Index of Industrial Production numbers are correct, disinflation hasn’t been painless in India. Industrial production growth was just 1.14 percent in March, well below expectations and widely at variance with the PMI data. That suggests once again a K-shaped economy, a view reinforced by the production of consumer non-durables or staples, which shrank by 3.1 percent from a year ago, while consumer discretionary production fell by 8.4 percent.

Indeed, if the IIP numbers are to be believed, consumer staples production is lower than what it was back in March 2018, while that of consumer durables is lower than in March 2016. The index for manufacturing is just 1 percent higher than it was back in March 2019.

But there is little doubt that inflation is coming down globally. Crude oil prices have retreated, despite a production cut by the oil cartel. One reason is disappointment over China’s rebound-- inflation in that country was a mere 0.1 percent year-on-year in April, while producer prices were in outright deflation. Silver, copper and iron ore prices are all down on China’s weak industrial outlook. Here’s an FT report, free to read for MC Pro subscribers, on China’s forgettable sideways market and why Warren Buffett prefers cash.

A closer look shows a two-speed global economy. The JP Morgan Global Composite PMI report for April said, ‘Scratching beneath the surface of the data showed contrasting trends at manufacturers and service providers..... While the pace of inflation signalled for both price measures (input and output prices) eased in manufacturing, accelerations were signalled in the services sector.’ That reflects the difference in growth between the two sectors---the services sector is doing much better.

But surely, if we have immaculate disinflation, markets should have taken off like a rocket? Instead, investors seem to be nervous. They realise disinflation may get less and less immaculate as time goes on and if central banks do not cut rates. The Fed has warned of the risk of a credit crunch, and this FT article by Mohamed El-Erian talks about how to avoid further banking tremors.

As inflation falls and policy rates remain elevated, high real interest rates will start to hurt growth. The markets are at the moment betting it’s very likely that the Fed will start cutting rates at its September meeting. That in turn will support growth—this is the belief supporting the US markets.

In India, there are several reasons for optimism. One is relatively strong overall growth, aided and abetted by lower commodity prices—although the IIP numbers are worrying. Another is the prospect of a revival in the capex cycle. The fall in inflation has already led to a rally in the local equity market and to the return of foreign portfolio inflows.

There are hopes that lower inflation will lead to the revival of rural demand, which will boost FMCG stocks. We accordingly predicted higher volume growth and better margins for Godrej Consumer Products. Margins are at peak levels for Britannia, while they are slated to improve for Marico. Declining VAM prices should boost Pidilite’s margins.

Mahanagar Gas and Gujarat Gas have been prime beneficiaries of soft spot gas prices. Volumes also grew for Hero Moto Corp while Eicher posted stellar numbers. The government’s infrastructure push has led to strong growth for HG Infra Engineering.

But there is a flip side to cooling commodity prices, as seen from Coal India’s results. High-cost inventory, along with other woes, took a toll on UPL. The exuberance on PSU banks may be dented by expected credit loss provisioning.

And finally, there is also the worry about the monsoon, as we pointed out in our analysis of Escorts. A strong El Nino would be enough to say goodbye to disinflation.

Most economists have pooh-poohed the idea of immaculate disinflation. A paper in February this year titled ‘Managing Disinflations’ by a group of US economists said that all the large policy-induced disinflations in four advanced economies since 1950 were associated with recessions. They added, ‘Hence, in the current circumstances that already involve significant policy tightening (and a prospect for further restraint), an “immaculate disinflation” would be unprecedented.’

And in April this year, an NBER working paper, ‘Disinflation and the stock market: Third World Lessons for First World Monetary Policy’, found that while the stock market viewed disinflation from runaway inflation episodes positively, its reaction to disinflation from moderate inflation was negative.

The paper concludes: ‘Whether in advanced economies or the developing world, no team of policymakers has ever executed an immaculate reduction of inflation from moderate to low………..Ironically, the stock market, which in the US has been yearning for signs that interest rates will not remain higher for longer, actually provides the strongest evidence that a quick return to the Fed’s target is highly unlikely. Policymakers—and financial markets—ignore this lesson at their own peril.’

The markets’ current faith in immaculate disinflation, it appears, is blasphemy.

This week, in view of the increasing popularity of options trading, we kicked off a series of articles titled ‘In the Money’, which will guide you step-by-step into the world of options trading.

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 

Paytm, SRF, Nazara Technologies, Dr Reddy’s, Aarti Industries, Aditya Birla Fashion & Retail, Weekly tactical pick, L&T, DCB Bank, Cholamandalam

IPO 

Nexus Select Trust REIT

Markets 

The smart way to buy bullion for maximum returns

King Dollar and Queen Gold

Economy 

International food inflation rises, but India has little to worry

MC Pro Economy Tracker

Bangladesh vs India per capita GDP—setting the record straight

Policy 

Draconian PMLA extends its tentacles to finance professionals

The Green Pivot: Indian banks aren’t doing green financing

A small step forward for regulation of core investment companies

Financial Times 

Why Warren Buffet prefers cash

Google: AI additions to search should stave off rivals

Tim Harford: One group of people can’t substitute their way out of inflation

Companies and industry 

LatentView Analytics

Geopolitics 

Rupee’s global ambitions suffer a setback

Internet nationalism in China

Green Pivot on critical minerals

Politics 

Manipur ethnic strife

Manipur: The horrors of identity politics

Others 

GuruSpeak—the chartered accountant with a trading strategy for every market condition; Personal Finance—choosing between AIFs, PMS or MFs, What Indian companies can learn from the fate of GE and Intel; Startup Street: Are startup incubators worth it?; Will ONDC eat Zomato’s and Swiggy’s lunch?