Moneycontrol Pro Weekender | When Jerome Powell sneezes…

Yet the small rebound after Jay Powell’s press conference fizzled out in a day and the markets plunged again

Dear Reader,

Sentiment in the equity markets is at extreme lows. A Bank of America survey of global fund managers, carried out between the 3^rd and 10^th of this month, found that global growth optimism was at an all-time low, that fear of stagflation was the highest since the Global Financial Crisis, and their outlook on corporate profits the worst since the Lehman bust.

Even before the Fed meeting, therefore, market sentiment was terrible, but a 75 basis point hike was already baked in, as was another 75 bps hike at the July meeting. With so much pessimism in the air, it was an ideal setting for a nice bear market rally.

Yet the small rebound after Jay Powell’s press conference fizzled out in a day and the markets plunged again.

What could be the reason? Yes, Powell was insistent that he was determined to stamp out inflation. But the markets already knew that. The market’s concern is whether the Fed will be forced to tighten too much to quell inflation and that could lead to a recession.

What was new at Powell’s press conference? In reply to a crucial question by the FT reporter: “Are you more concerned now that to bring down inflation it will require more than just some pain?” Powell said, “What's becoming more clear is that many factors that we don’t control are going to play a very significant role.” He then went on to talk about commodity prices, the war in Ukraine and supply-side bottlenecks. He also said, in reply to another question, that the Fed has to target headline inflation, because that is what shapes inflationary expectations, which are the drivers of inflation. But headline inflation and inflationary expectations are in large part determined by energy and food prices. That means the Fed may have to dampen demand until it can offset supply-side inflation, over which it has no control. It’s a very uncomfortable situation to be in. This FT article, free to read for Moneycontrol Pro subscribers, says shaping public perception may be beyond Jay Powell’s control.

Interestingly, the RBI’s ‘State of the Economy Report’ echoes these concerns when it says, “Will these monetary policy actions exorcise the evil spirit of inflation? Who knows till when the war in Ukraine would last? But the RBI has to act.”

Powell also said, in response to other questions: “It's not getting easier, it's getting more challenging”; “pathways have become much more challenging due to factors beyond our control”; “very difficult situation to be in”; “what you're seeing is the situation becoming more difficult” -- all of which indicate the Fed chair is far from confident. That lack of confidence is percolating down to the markets.

In the Bank of America survey referred to above, 32 percent said “hawkish central banks” are the biggest tail risks to markets, followed by 25 percent who said it was “global recession”, while another 22 percent said it was inflation.

Comparing the current situation with the 1970s is much in vogue these days and a research paper by Harvard professor Lawrence Summers finds that the disinflation the US has to achieve today is similar to that of the Volcker years, which means the markets will have to prepare for a long and bruising battle against inflation. Indeed, this piece argues that just as the turmoil of the 70s led to a turn towards free markets and free trade in the 1980s, the disruptions today will usher in a new economic paradigm.

Be that as it may, note that financial conditions in the US are still not tight enough. My colleague Neha Dave points out that for the US markets, while valuations have corrected, that is usually a signal for earnings downgrades to follow. And let’s not forget that it’s not just the Fed Funds rate that is going up, central banks are also doing Quantitative Tightening.

The RBI Bulletin’s State of the Economy report for this month says that as far as India is concerned, “The recovery remained broadly on track. This demonstrates the resilience of the economy in the face of multiple shocks and the innate strength of macro fundamentals as India strives to regain a sustainable high growth trajectory.” It added, “What the RBI is trying to do is to stabilise the price situation when the economy is able to bear it.” UBS India economist Tanvee Gupta Jain expects the repo rate to be 6.25 percent in FY23, compared to 4.9 percent now. This piece said inflation in Asia hasn’t yet peaked.

For the Indian markets too, the RBI’s efforts to dampen demand and cost pressures are likely to lead to earnings downgrades, as my colleague Vatsala Kamat pointed out. While the valuation froth has diminished, further de-rating is possible due to demand destruction. The prospects for a revival of rural FMCG demand don’t look bright yet and our Economy Recovery Tracker shows consumer sentiment dipping. Then, of course, there are the constant FII outflows, and we examined why Indian retail investors are buying while FIIs are selling and why gold is refusing to act out its traditional safe haven role.

This may be the time to cherry pick quality stocks and the ones we considered this week included City Union Bank, VA Tech Wabag, a market leader in refractories, Ujjivan SFB, Federal Bank and Sona BLW. We also looked at the prospects of the cement, retail and city gas distribution sectors. Hospitals and pharma companies such as Laurus Labs, of course, march to the tune of a different drummer.

We had all our regular features—FX Learn on how to trade non-directional currency options; Crypto Conversations on why ERC-1155 is special; Start-up Street on why Fintech is back; Personal Finance on the reviving charms of fixed income and Monsoon Watch on the rains picking up speed. This week, we’ve re-started The Green Pivot, a special series to chronicle the impact of green technology and climate change.

The Bank of America survey points out what is different about the lows in the market this time around. It says, “Normally at a ‘big low’, investors universally expect central banks to panic and cut rates… in 2022, the central bank panic is in the other direction, hiking rates to desperately reverse their excess stimulus of 2020 and 2021.”

Cheers,

Manas Chakravarty