4 key implications for Indian markets and portfolio strategy after US Fed policy meeting: Dhananjay Sinha

The US Federal Reserve has taken an affirmative stance on the path of monetary policy normalization with its patience in the face of high inflation running out and has now started to impact growth.

The emphasis on the transient nature of high inflation has diminished considerably. The advent of the QE cut from November 21 is a sealed result and the take-off of rates from 2022 is now a categorical view of FOMC members.

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They (the US Fed) are forecasting a series of seven rate hikes through the end of 2024. The speed of normalization can be accelerated if inflation remains persistent. Thus, our prospects for a strong USD, weakening commodities and our preventive repositioning of the portfolio based on the theme of global inflation (Jul’21, see here) are strengthening.

Key points to note:

– Type to start in November 21, QE to end in mid-2022

– Take off in rates from 2022, cumulative 7 increases seen until the end of 2024

– the inflation targets of the FOMC are more than achieved; employment also widely achieved; the lack of existing manpower is only technical, the situation is in fact very tense

– Obvious short-term stagflation: a) Growth projections for 2021 revised downwards from 110 bps to 5.9%, but future trajectory still described as robust and b) Inflation projects increased by 80 bps to 4.2% in 2021, core PCE up 70bp to 3.7%, is expected to remain above 2% even by the end of 2024.

Also Read: Federal Reserve Keeps Interest Rates Steady, Aims To Promote Jobs And Control Inflation

Our reading of the FOMC statement:

a) The US Fed now believes that quantitative easing (QE) as a tool to support the economy has lost its usefulness and must therefore be reinstated. A gradual tapping will certainly start from the next meeting on November 21 and end in mid-2022, implying a monthly reduction of around $ 20 billion from the current QE of $ 120 billion / month. Taper can be accelerated if inflation remains high and the job trajectory is better.

b) The decision on tapping it will no longer depend on incremental data as the US Fed will now examine cumulative evidence for the jobs scenario through November 21.

Given that the FOMC estimates that the recent shortages were caused by the spread of the Delta variant, the fact that 11 million open jobs far exceed the level of unemployment, the labor market has effectively passed the litmus test.

The effective unemployment rate is likely much lower than the 5.2% report for August 21 and is expected to drop below long-term levels of 4% in 2022.

c) With all inflation measures well above the target of “slightly above 2%”, the target on the price stability front was met a long time ago.

d) In particular, President Powell has abandoned his earlier emphasis on the transient nature of high inflation. From the questions and answers, it appeared that while the PCE’s medium-term inflation projections remain anchored at 2.2% (2022-2023), the level of inflation increased to 4.2% and the Core inflation at 3.7% in 2021 reflects a decline in patience with inflation. This is reflected in the Fed’s new assessment that supply bottlenecks, made worse by the spread of the delta variant, are longer lasting than previously thought and are hurting growth.

e) Greater openness to the possible scenario of a tariff take-off in 2022 itself. All but one in 18 members are forecasting a rate hike from 2022. The median expectation is 7 cumulative Fed rate hikes of 25bp each through the end of 2024 to 1.8%.

This would take the actual Fed rate from -4.2% currently to -0.25% by the end of 2024. We believe this take-off path may undergo a new calibration as 2022 approaches.

f) On the possibility of a reduction in the balance sheet, the Fed would first develop the tapering before that. Given the past normalization path, we assume a reduction in the balance sheet until the end of 2024 ($ 15-20 billion per month) after QE ends by mid-2022.

g) The Fed sees no risk for the United States of the real estate contagion in China, as American banks have little exposure and American companies are in good balance sheet position thanks to the big stimulus. However, there can be multiple channels of implications for the global economy.

Main implications:

The US Federal Reserve’s new normalization forecast is in line with our expectation of a “tough decline” guided by a downward growth outlook and higher inflation projection. Waning patience in the face of high inflation adds to the dimension that many FOMC members articulated earlier.

a) Thus, we maintain our projection of the American money supply (M2) / GDP going from 89% currently to 80% by the end of 2024. This should have a downward bias on the multiple of the Indian markets.

b) A solid view of the dollar and the outlook for easing commodity prices are maintained. FII flows are expected to continue at a moderate pace as we saw on April 21. Although the ECB has also started debating tapering, it should follow the Fed (see here).

c) The contagion of the Chinese housing and construction sector and the slowdown in growth did not surprise us, its persistence in the absence of a significant bailout for the Evergrande debacle should strengthen our UW position in metals since May-June 2021; we think that in a few months it will become a consensus.

d) The course of a stagflation situation can be thankless for deep cyclics

Portfolio strategy:

Therefore, our focus on national themes, in particular consumption, government directed spending and the IT sector remains. We have been EW banks, UW commodities and selective on capitalization goods and small and mid caps.

(Author is MD & Chief – Strategist, JM Financial Institutional Securities)

(Disclaimer: The views / suggestions / advice expressed here in this article are solely by investment experts. Zee Business suggests that its readers consult their investment advisers before making a financial decision.)


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Don F. Davis